You are given the following data on three securities, A, B, and the market, M:
|
Security
|
Expected
Return (R-)
|
Standard Deviation(σ)
|
Covariance with "M" Cov(R, RM)
|
|
A
|
10%
|
15%
|
225
|
|
B
|
10%
|
15%
|
180
|
|
M
|
10%
|
15%
|
225
|
Note: The risk-free rate is RF = 5%.
a. Compute the correlation between A and the market, and B and the market.
b. Based on your answer to part (a), which of the two securities, A or B, is better to be combined into a portfolio with M? Explain briefly.
c. Compute the expected return and standard deviation for a portfolio formed between M and your choice in part (b). Then compute the weighted-average standard deviation of this portfolio and explain why the portfolio's actual standard deviation is less than just holding any of the three securities, all of which have a standard deviation of 15% and an expected return of 10%.
d. Compute the systematic risk β CAPM expected return for your choice in part (b). Why is it less than 10%? Explain in the context of systematic and total risk.