4. (18 points) Mike Wheeler has been learning about data and regressions in science club. He has the following estimates of betas for 5 portfolios. These portfolios vary according to the historical book to market ratio. In particular, stocks in portfolio P1 had the lowest book to market ratio and stocks in P5 have the highest book to market ratio at the end of last year. Over the next month, the realized return of the market was 1.0%, the realized return on the risk free asset was 0.40%, and the realized returns on the book to market portfolios varied from 0.94% to 1.52%. Data on the betas and realized returns are in the following table. P2 P3 P4 Portfolio Book to Market Beta Realized Return P1 Low 0.90 0.94% P5 High 1.2 1.52% 1.02 1.10% 1.08 1.28% 1.15 1.40% Mike's friend Dustin thinks something looks upside down with the data, and they begin to argue. Their friend Lucas thinks they're both crazy. To help Mike and Dustin explain the problem to Lucas, you have plotted the SML and the realized returns. 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 0.2 0.4 0.6 0.8 1 1.2 1.4 a) Label the axes on the graph. b) Show where the market portfolio is on the graph. Label this point M. c) Show where the risk free asset is on the graph. Label this point F. d) Calculate the CAPM expected returns for Portfolios P1 and P5. e) Show where Portfolios PI and P5 would plot on the SML if the realized returns equal CAPM expected returns. Label these points Pl and P5. f) Label the two boxes where Portfolios P1 and P5 actually plot on the same graph according to the realized returns you estimated. Label these points Plreal and P5real. g) Calculate the alphas for P1 and P5. h) If CAPM is true, Portfolio Pl is -priced and Portfolio P5 is -priced