Question: You are given the following information on two securities, the market portfolio, and the risk free rate:
|
|
|
Correlation with |
|
|
Expected Return |
Market Portfolio |
Standard Deviation |
|
|
|
|
|
|
Security 1
|
15.5%
|
0.90
|
20.0%
|
|
Security 2
|
9.2%
|
0.80
|
9.0%
|
|
Market Portfolio
|
12.0%
|
1.00
|
12.0%
|
|
Risk free rate
|
5.0%
|
0.00
|
0.0%
|
For parts a, b, and c, use the above Table.
a. Draw the Security Market Line.
b. What are the betas of the two securities?
c. Plot the two securities on the Security Market Line.
d. Now assume that the two securities 1 and 2 constitute the market portfolio. Their proportion in it and variances are 0.39, 160, and 0.61, 340 respectively. The covariance of the two securities is 190. Calculate the betas of the two securities.
e. Why should the expected return for a security be directly related to the security’s covariance with the market portfolio?