Consider two potential portfolios,AandB. Based on current dividend yields and your estimates of expected capital gains, you expect rates of return on portfolioAis 12% and on portfolioBis 16%. The standard deviation of portfolioAis 12% annually, and the standard deviation of portfolioBis 31%.

You have determined that the Beta of portfolioAis 0.7, while the Beta of portfolioBis 1.4. The current risk-free (US Treasury) rate is 5.0%. Your estimate for the expected return of the S&P 500 market index is 13%. The standard deviation of the S&P 500 index is 18%.Questions:

a.If you currently hold only the market index portfolio, would you choose to add either of these portfolios (eitherAorB) to your overall portfolio? Explain and show your work. (Hint: think about the CAPM).

b.IF instead you could invest ONLY in Treasuries and ONLY ONE of these portfolios, would you chooseAorB? Why?