1. (CAPM) The following table shows information for two assets and the market portfolio (16%). Correlation Asset Average Annual Return Standard Deviation Beta with m 1 0.2 0.5 2 0.25 0.9 Market portfolio 0.1 0.15 1 1 Also, suppose that the risk-free rate r -.05. 1) What should be the expected return of stock I and of stock 2 according to CAPM? (5%) 2) Suppose that the correlation between the return of stock I and return of stock 2 is 0.5. Find the expected return and the standard deviation of the return of a portfolio P that has a 50% investment in stock I and a 50% investment in stock 2. (5%) 3) Continue assuming CAPM is valid. Can you construct a new portfolio using the market portfolio and the risk-free asset that has the same expected return as the portfolio P you considered in part 2 but has a lower standard deviation? If yes, how to construct the new portfolio? Briefly describe why you can or cannot. (Graph can be used to illustrate) (6%) SML: E(r)=r,+B. (Elr.)-,) CML: E(v)=r, + (EC...--,) Covor.) B= Covr, r.) = P200. Var(r) Varlar, +br.) = a*Var(r.)+b+Var(r.)+ 2ab Cov(ri,r)) Elar, + br.) = a(r+bE(r.)