Question 2 [5 pts]

Use the information for two firms and the market portfolio summarized in the table below to answer questions (a) and (b). (Lecture notes p.12, pp.15-17, also the discussions in pp.6-14)

	Firm A	Firm B	Market portfolio
Variance	0.025	0.045	0.010
Covariance with the market portfolio	0.016	0.008	-

Determine which stock, under the CAPM framework, has a higher systematic risk.

Answer (show the steps/calculation toward your results):

b.Suppose the market risk premium (not the expected return on the market portfolio) is 5%. The risk-free return is equal to 6%. Calculate the CAPM predicted return on firms A and B, respectively.