Suppose that there are only two stocks in the stock market. Stock A sells for $20 and has 100 shares outstanding. Stock B sells for $40 and has 200 shares outstanding. Assume that there is a risk-free asset.
a. What is the market portfolio in this hypothetical economy?
b. If the beta of stock A is 1.2, what is the beta of stock B?
c. If the stocks have volatilities 20% and 30%, and if all investors have quadratic utility so that the CAPM accurately describes the data being used, what is the equilibrium expected return (or equilibrium expected return or the CAPM implied expected return as practitioners call it) on the stocks in excess of the risk-free asset?