The risk-free rate of interest is 5%. Stock ABC has a beta of 1.4. The expected return on the market portfolio is 12%. Assume CAPM holds. (note: the questions below are independent, not sequential.)
a. Plot the security market line in expected return, beta space. Label all axes and the points representing the expected return for the market portfolio, the expected return for stock ABC, and the risk free rate. Be sure that you note the expected return and beta for all of these points.
b. What is the expected return of a portfolio that has a 40% investment in the risk free asset and an 60% investment in stock ABC?
c. If a portfolio of these two assets (the risk-free asset and stock ABC) has a beta of 0.6, what are the portfolio weights (i.e. what percent of the total portfolio is invested in each asset)?
d. If a portfolio of the two assets (the risk-free asset and stock ABC) has an expected return of 14%, what is the portfolio's beta?
e. If a portfolio of the two assets (the risk-free asset and stock ABC) has a beta of 2.0, what are the portfolio weights? How do we interpret the weight for the risk-free asset?