b) A market consists of only two stocks, X and Y. The market cap of X is $3bn and that of Y is $7bn. X has an expected return of 10% and a return standard deviation of 32%. Y has an expected return of 8% and a standard deviation of 20%. Their return correlation is 0.25.

i) What is the expected return on the market and the return standard deviation of the market?

(10 marks)

ii) What are the CAPM betas of X and Y?

(10 marks)

c) Assume that you believe in the Capital Asset Pricing Model. You believe that you have, through extensive research, identified a stock that plots below the Security Market Line. What does this imply for whether or not it is fairly priced? How would you exploit this situation? [Write no more than 5 sentences in your answer.]

(10 marks)

c part answer required urgent