Q1. The risk-free rate is given by Rf = 2.5% and the expected return on the market is E[RM] = 8%. What is the equilibrium return of a security that has = 0.5?

(a) 4%

(b) 5.25%

(c) 6.5%

(d) 10.5%

Q2. Consider again the security market line of the previous question. A security has a covariance with the market that is half the variance of the market. The securitys expected return is 5.75%. Can the investor make an arbitrage profit?

(a) No. The security is correctly priced.

(b) Yes. One can buy the security and sell a portfolio with weight X = 0.318 on the risk-free and the rest on the market portfolio.

(c) Yes. One can buy the security and sell a portfolio with weights X = 0.5 on the risk-free and the rest on the market portfolio.

(d) Yes. One can sell the security and buy a portfolio with weights X = 0.5 on the risk-free and the rest on the market portfolio.