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Problem 2 (25 marks). Consider the following properties of the returns of stock 1, the returns of stock 2 and the returns of the market

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Problem 2 (25 marks). Consider the following properties of the returns of stock 1, the returns of stock 2 and the returns of the market portfolio (m): Standard deviation of stock 1 Standard deviation of stock 2 Correlation between stock 1 and the market portfolio Correlation between stock 2 and the market portfolio Standard deviation of the market portfolio Expected return of stock 1 q = 0.30 Oz = 0.30 Pi,m-0.2 P2.m-0.5 E(r) = 0.08 Suppose further that the risk-free rate is 5%. a) According to the Capital Asset Pricing Model, what should be the expected return on 10 marks b) Suppose that the correlation between the return of stock 1 and the return of stock 2 is 0.5. What is the expected return, the beta, and the standard deviation of the return of a portfolio that has a 50% investment in stock 1 and a 50% investment in stock 2? the market portfolio and the expected return of stock 2? 10 marks)

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