The S&P500 Index portfolio may be viewed as the market portfolio for CAPM Average Return Standard Deviation Beta Portfolio Money Market 2% 0% 0.0 Portfolio A 10% 16% 0.6 Portfolio B 15% 25% 1.2 S&P500 Index 14% 20% 1.0 (a) Compare the Sharpe Ratio for A and B against the market Sharpe Ratio. If the CAPM holds which would you expect to have the larger Sharpe Ratio? (b) Under the assumptions of the CAPM what is the idiosyncratic standard deviation of A and B returns? (c) Given that the CAPM holds exactly, what is A and B alphas? (d) Find the correlation between A and B returns and the S&P500 Index return. (e) What is A cost of equity capital based on the CAPM? (f) Explain whether A portfolio lies on, below, or above the CML. Show in the graph (g) Explain whether A and B portfolios lie on, below, or above the SML. Show in the graph. Do you think that the A and B portfolios are underpriced, overpriced, or priced correctly? Explain.
