Suppose that the expected riskfree rate of return is r_f = 1.92 (yield on 10-year Treasury Strip on 12/31/19), the expected return on the market is r_M = 8.0%, and the total risks (the annualized standard deviations from our sample) are 13.8% for the market, 17.9% for the small cap index, and 10.0% for Gold (the standard deviation for the market is about a third lower than its historical average, as is that the small caps standard deviation, while golds standard deviation is much lower). Use the betas calculated in Part I.

Gold Beta -.04

Small Cap Beta 1.16

a. According to the CAPM, what are the expected annual returns for the Gold and small cap indices (HINT: Use the beta version of the SML)?

b. According to the CAPM, what are the systematic and nonsystematic risks for the Gold and small cap indices? (To answer this question correctly, you need to work with variances. See pages 30-31 of Reading 3-1 and the solutions to self-test 3-2 for numerical examples of how to do this.)

c. Compared to the small cap index, Gold exhibits significanlty less total risk (exceptionally ususual), yet 50% more nonsystematic risk. Even so, Gold has very little systematic risk. (Express all risks and risk segments as variances.) Whats driving this result?