Question

Assume for parts (a) to (c) that the Capital Asset Pricing Model holds. The market portfolio has an expected return of 5%. Stock A's return has a market beta of 1.5, an expected value of 7% and a standard deviation of 10%. Stock B's return has a market beta of 0.5 and a standard deviation of 20%. The correlation between stock A's and stock B's returns is 0.5.

1.what the risk-free rate? What is the expected return on stock B?

risk free rate = 1%

expected return on stock B = 3%

Is it correct?

(b) Draw a graph with expected return on the y-axis and beta on the x-axis. Indicate the approximate position of the risk-free asset, the market portfolio and stocks A and B on this graph. Draw the Securities Market Line (SML), which connects these four points. What is the slope of the Securities Market Line?

show me the SML how to draw the graph

(c) Suppose you expect the realized average return on stocks A to be 7% and B to be 2%. Given the SML in part (b), what strategies would you recommend to profit from this opportunity?

which strategies should we take to profit from this opportunity?

Answer 1