Using the information regarding risk aversion you gathered in Question 1 you decide to advise you clients to invest funds in the market portfolio and the risk-free asset. You gather historical data on NYSE stocks (the market portfolio) and determine that the average return of stocks is 11.7% and that the risk premium is 8.1%. NOTE changes. The standard deviation of stocks is 20.0%. You analyze the risk and return possibilities of a 1-year investment in the stock market and the risk-free asset.

a. The current risk-free rate over past year has changed with FED policy and moved up from 0.5% to 2.0% and now up to 5.0%. This is the new intercept of the CML. Given the historical experience of stocks what is the slope of the CML (the Sharpe ratio history of the market)?

b. Using the changed intercept and slope of the CML, plot the shift of the line in risk return space. What is the expected return of the risky portfolio Rp? (Hint: To calculate the expected return, add the changing risk-free rate to the historical risk premium above; also note that the standard deviation is given above.)