You are trying to decide whether to invest in one or both of two different stocks. The market risk premium and riskfree rate are 6 percent and 4 percent respectively.
Use your knowledge of the CAPM and the SML which you learnt in this course and determine whether you should invest in either, one, or both of these stocks. Provide all workings to support
Beta 
Expected Return (%) 

Stock 1 
0.8 
7.0 
Stock 2 
1.2 
9.5 
your answer.
As per CAPM,
E(R) = Rf + (RmRf)beta
Rf = Risk free rate
Rm = Market risk premium
Stock 1 and 2
7 = Rf + (RmRf)10.80. Equation 1
9.50 = Rf + (RmRf)21.20. Equation 2
Substracting equation 2 from 1 we get
2.50 = 10.40(RmRf)
0.2404 = Rm  Rf
Rm = 0.2404 + Rf
Putting in equation 1
7 = Rf + (0.2404 +Rf  Rf)10.80
Rf = 4.4037 %
Rm = 0.2404 + 4.4037 = 4.6441 %
Since the risk premium is low in comparison to actual 6% for bearing risk at market portfolio.
Expected return is low for bearing the given level of beta so amount should not be invested in these two stocks because of lower premium.
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