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Please help, I'm confused Consider the following properties of the returns of Stock 1, of Stock 2 and of the market (m): 01 = 20%

Please help, I'm confused

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Consider the following properties of the returns of Stock 1, of Stock 2 and of the market (m): 01 = 20% Pl.m = 0.4 02 = 1 15% P2,m = 0.7 = 12% E(Tm) = 8% where E(rm ) represent the excess return of the market portfolio. Suppose further that the risk-free rate is 4%. 1. According to the Capital Asset Pricing Model, what should be the expected excess return of Stock 1 and of Stock 2? 2. Suppose that a single index model that uses the market portfolio as a factor fits well the data for the returns of Stock 1 and Stock 2. What can you learn about the correlation between the return of Stock 1 and the return of Stock 2? 3. What is the expected return and the standard deviation of the return of a portfolio P that has a 30% investment in Stock 1 and a 70% investment in Stock 2? 4. Using what you have learned in 3 about the portfolio P, would it be advisable to switch to a portfolio made up of the market portfolio and the risk free asset? Why? (Hint: check the Sharpe ratio of the two portfolios)

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