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 0.50.5,

and the following characteristics:

Particulars Expected Return Volatility

Value stock 11 10

Growth Stocks 17 21

The risk free-rate is 2%

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