Expected returns as well as risk in portfolio.
When the CAPM holds with E (RM) =12%, σM = 20% and Rf = 2%,
(a) What must be the expected return of stock X that has a standard deviation σX = 30%, and a correlation with the market portfolio of ρXM = 0.6.
(b) Presume that stock Y has the same standard deviation as stock X i.e., σy = 30%, however the correlation with the market portfolio ρYM = 0.2. Calculate βY and E (RY). Explain what can you learn by comparing results in (a) and (b)?
(c) A portfolio p of consisting 60% of stock X and 40% of stock Y has a correlation ρpM = 0.62 with the market. Explain what is the portfolio volatility and Comment on the diversification effect!