(Each of the following parts is independent.)

1. According to the Capital Asset Pricing theory, what return would be required by an investor whose portfolio is made up of 40% of the market portfolio (m) and 60% of Treasury bills (i.e. risk-free asset)? Assume the risk-free rate is 3% and the market risk premium is 7%?

2. You are considering investing in the following two stocks. The risk-free rate is 7 percent and the market risk premium is 8 percent.

Stock	Price Today	Expected Price in 1 year	Expected Dividend in 1 year	Beta
X	$20	$22	$2.00	1.0
Y	$30	$32	$1.78	0.9

1. Compute the expected and required return (using CAPM) on each stock.
2. Which asset is worth investing? Support your answer with calculations.

3. Which pair of stocks used to form a 2-asset portfolio would have the greatest diversification effect for the portfolio? Briefly explain.

	Correlation
Stocks A & B	-0.66
Stocks A & C	-0.42
Stocks A & D	0
Stocks A & E	0.75

(d) Explain the terms systematic risk and unsystematic risk and their importance in determining investment return.