1) You built a portfolio consisting of two assets. After two quarters, the standard deviation of one of the assets decreases by 200 basis points, but the weights and the correlation between assets do not change. Once that change occurs, must the portfolios standard deviation decrease? Explain.

2) In Capital Market Theory, we assumed no transaction costs, which seemed unrealistic. However, there are instances where this assumption is not completely invalid. One such case is residential real estate, where only the seller typically pays a commission for a transaction. Assume the risk-free rate is 6%, sales commissions are 3%, and the SML is a positively-sloped line (i.e. normal). In words, graphs, or both, explain how this type of commission would alter the SML and the pricing of residential real estate assets.

3) Oh no! You have somehow miscalculated the risk-free rate, with your estimated rate 100 basis points below the correct risk-free rate. What are the implications for a) portfolio allocation and b) the pricing of assets? Be as thorough and specific as possible.