Item 1

Suppose that many stocks are traded in the market and that it is possible to borrow at the risk-free rate, r. The characteristics of two of the stocks are as follows:

Stock	Expected Return	Standard Deviation
A	8%	40%
B	13%	60%
Correlation = 1

Required:

a. Calculate the expected rate of return on this risk-free portfolio? (Hint: Can a particular stock portfolio be formed to create a synthetic risk-free asset?)

Rate of return= %

b. Could the equilibrium r be greater than rate of return?

• Yes

• No