(CAPM)

The Triple Happiness Mutual Fund's investment portfolio previously included only risk-free assets [say U.S. T-bills], and a well-diversified (market) portfolio [say, S&P500], but has no specific investments in real estate. The fund has planned to diversify its investment portfolio to include indirect real estate and considered purchasing shares of three real-estate related listed companies.

The following table shows the (incomplete) estimates of the risk for the shares of the three companies during the five years ending Nov 2018:

Company	Expected Return	Standard Deviation (SD)	beta	Residual standard deviation
A	17%	???	1.2	15%
B	???	25%	0.8	5%
C	7%	20%	0.4	???

(Express your answers in 4 decimal points if necessary)

Denote the risk-free rate by rf and expected rate of return of market portfolio, M.

(a) What are the major assumptions beneath CAPM? (8 marks)

(b) Suppose that CAPM holds. Compute the missing information above. (10 marks)

(c) Suppose B is mispriced according to CAPM and its corresponding expected return in the market is at 10% (B = 10%).

i. Whether B is overpriced or underpriced? (3 marks)

ii. Apply Treynor-Black model to construct an optimal risky portfolio to compute its risk premium, variance and Sharpe ratio. (12 marks)