11-9

Suppose you group all the stocks in the world into mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the following characteristics: The risk free-rate is 4%.

a. What is the expected return and volatility of the market portfolio (which is a 5050 combination of the two portfolios)?

b. Calculate the Sharpe ratios of the value stock, growth stock, and market portfolio.

c. Does the CAPM hold in this economy? (Hint: Is the market portfolio efficient?)

a. What is the expected return and volatility of the market portfolio (which is a 5050 combination of the two portfolios)?

The expected return of the market portfolio is ______% (Round to one decimal place.)

The volatility of the market portfolio is ______% (Round to one decimal place.)

b. Calculate the Sharpe ratio of the value stock.

The Sharpe ratio of the value stocks is ______ (Round to two decimal places.)

The Sharpe ratio of the growth stocks is _______ (Round to two decimal places.)

The Sharpe ratio of the market portfolio is _____. (Round to two decimal places.)

The CAPM does not hold, that is, the market portfolio is not efficient, because the market portfolio is not the portfolio with the highest Sharpe ratio.

Value Stocks Growth Stocks Expected Return 10% 15% Volatility 9% 26%