Suppose that there are only two stocks, X and Y, listed in a market. There are 200 outstanding shares of stock X and 600 outstanding shares of stock Y. Current prices per share are pX = 40$ and pY = 20$.
(i) What is the market portfolio in this market?
Suppose that the expected returns on stocks X and Y are μX = 10% and μY = 20%.
Standard deviation of returns are σX = 15% and σY = 30%. Covariance between the returns is zero, that is σXY = 0.
(ii) What are the expected return and the standard deviation of return on the market portfolio
(iii) Calculate market betas, βX and βY , for stocks X and Y . Suppose that the risk-free rate of return is r0 = 8%.
(iv) Verify that the Security Market Line holds for both stocks.