Suppose that the risk%u2010free rate of interest is 5 percent the market risk premium is 6 percent and the
market standard deviation is 20 percent.
a. Plot the risk%u2010free asset and the market portfolio on coordinates with expected return on the
vertical axis and total risk (standard deviation) on the horizontal axis. Plot both assets on
coordinates with expected return on the axis and market risk (beta) on the horizontal axis and
sketch in the security market line.
b. Suppose the CAPM is correct and that an asset with a standard deviation of holding period
returns of 30 percent has an expected return of 12 percent. Plot the asset on both sets of
coordinates. How much of the total risk of the asset is market risk? What is the correlation
between the asset and the market portfolio.
c. Explain why another asset with a standard deviation of holding period returns of 30 percent
could have an expected return of 10 percent. What would the asset%u2019s risk characteristics need