a) You are constructing a diversified portfolio. Among the companies you are considering are ABC Ltd (expected return 16.5%, standard deviation 30%, beta 1.5) and XYZ Ltd (expected return 13.8%, standard deviation 32%, beta 1.2). Should you be considering XYZ as part of your portfolio when XYZ is inefficient relative to ABC? Explain theory behind your answer. b) Consider three stocks: Q, R, and S. Standard deviation (annual) Q R S Beta 0.45 1.45 -0.20 35% 40% 40% A B C Expected returns 11% 14.5% 9% Forecast for the next year Use a risk-free rate of 2% and an expected market return of 9.5%. The market's standard deviation is 18%. Assume that the next dividend will be paid in one year. What should today's price be for each stock, assuming the CAPM is correct? The return on a dividend paying stock between time t-1 and t is calculated as Rt-1, (Pt+Dr-Pt-1)/Pt-1. Standard deviation Dividend $0.50 c) Expected returns and standard deviations of three risky assets are as follows: 30% 45% 30% 0 $1.00 Stock price $45 $75 $20 Correlations B 0.3 0.3 1.0 0.15 0.45 A 1.0 C 0.15 0.45 1.0 Compute the Sharpe ratio of a portfolio that has 30% in A, 30% in B and 40% in C. The risk- free interest rate is 4%. d) Describe step-by-step how you would test for the CAPM model using real data? Provide a rationale behind the test.