1. The Treasury bill rate is 4%, and the expected return on the market portfolio is 12%. Using the capital asset pricing model:

(a) Draw a security market line.

(b) What is the risk premium on the market?

(c) What is the required return on an investment with a beta of 1.5?

(d) If an investment with a beta of 0.8 offers an expected return of 9.8%, does it have a positive abnormal return?

(e) If the market expects a return of 11.2% from stock X, what is its beta?

3. Your investment portfolio consists of 15,000 invested in only one stock - Microsoft. Suppose the risk-free rate is 5%, Microsoft stock has an expected return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18% (volatility is the standard deviation). Under the CAPM assumptions:

(a) What alternative investment has the lowest possible volatility while having the same expected return as Microsoft?

(b) What investment has the highest possible expected return while having the same volatility as Microsoft? 1

(c) What is the volatility of the portfolio in part (a)?

(d) What is the expected return of the portfolio in part (b)?

(e) Plot the capital market line from the data above and mark the set of portfolios that dominates investing all your money in Microsoft stock. What is the market's Sharpe Ratio? What is the Sharpe Ratio for Microsoft stock?