Suppose you group all the stocks in the world into mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the

following characteristics:

[ value stocks : (expected return = 15%) (volatility = 14%) ]

[ growth stocks : (expected return = 19%) (volatility = 25%) ]

The risk free-rate is 4%.

a. What is the expected return and volatility of the market portfolio (which is a 50-50 combination of the two portfolios)?

b. Calculate the Sharpe ratios of the value stock, growth stock, and market portfolio.

c. Does the CAPM hold in this economy? (Hint. Is the market portfolio efficient?)

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