1) Consider a hypothetical economy with only three investments: the stocks of Hewlett Packard (HP), IBM, and Digital equipment (DEC). The prices per share of these three stocks are HP=$83.75, IBM=$90.00, and DEC=$62.60. The number of shares outstanding for these firms are 513.43 million (HP), 566.67 million (IBM), and 159.74 million (DEC) respectively.

The expected return of these three stocks are HP=12%, IBM=8% and DEC=9%.

1a) Find the expected return of the market portfolio. [Hint: Market value of a stock= (price of stock)*(number of shares outstanding)]

1b) Assume that the beta of IBM is 0.7 and CAPM is true. Find the risk free rate.