3. (12 points) All of the answers to this question refer to the following plot that indicates the tradeoff between expected return and standard deviation of investments in an economy in which the CAPM holds exactly. Mark the points with the question letter (e.g., a b marks the risk free rate). You might need to draw extra lines or curves.

a) Label the axes.

b) The risk free rate is 5%. Mark it on the plot.

c) Mark the market portfolio (you need to make it very clear on the plot why you chose one particular point.)

d) Mark the efficient frontier (of all assets, including the risk free asset).

e) Mark an efficient portfolio that consists of a positive weight in risk free and risky securities.

f) Mark an efficient portfolio that consists of a leveraged position in risky stocks.

g) Mark the portfolio of only risky assets that has the lowest standard deviation of all portfolios that consist ONLY of idiosyncratic risk (you need to make it clear on the plot why you chose one particular point). Recall idiosyncratic risk is risk that is uncorrelated with the market portfolio.

h) What is the beta of the portfolio in (g)?

i) Would an investor ever choose to invest all of their wealth in the portfolio in (g)? Explain why or why not.

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