Assume that the CAPM holds, but that the market portfolio is unobservable, so that the return on the market portfolio is unknown (therefore, so are the betas). The annual risk-free rate is 5%.

(a) Stock A will pay a dividend of $2 per share in one year and its dividend in subsequent years is expected to grow at a constant rate of 5% per year forever. Its current ex-dividend stock price is $40. Determine the expected return on Stock A.

(b) Stock B is expected to pay a dividend of $0.20 per share in a year, growing a constant rate of 10% per year forever. Its current price is $2. By how many times is Stock ABs CAPM beta greater than Stock As?

(c) Consider a portfolio that is 20 units of Stock B and short of 1 unit of Stock A. What is the expected dollar payoff on this portfolio if it is liquidated in one year?

(d) Suppose we learn that Stock Bs CAPM beta is 1.5. Draw the security Market Line, showing the positions of Stocks A, B, the risk-free asset, and the market portfolio on the SML. Make sure to indicate the betas and expected returns of each.

(e) what is the slope of the SML if Stock Bs CAPM beta is equal to 1 (rather than 1.5)?

(f) What problem with testing the validity of the CAPM do your answers to parts (d) and (e) above highlight. Explain.