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Assume that the CAPM holds and that the expected return on the market portfolio is E[Rm] = 0.07 and the standard deviation of market returns is om= 0.20. The correlation between the return on the market portfolio and the return on stock A is -0.05. The expected (CAPM) return on stock A is E[Ra] = 0.04 and the standard deviation of stock A's returns is on = 0.25. Q.1 What is the beta of stock A? Q.2What is the risk-free rate? Q.3There is also another stock, B. The observed (actual) return on stock B is E[RB] = 0.13, its standard deviation is OB = 0.55, its beta is Be = 0.14, and its returns are perfectly negatively correlated with returns on stock A (i.e., p = -1). Show that there is an arbitrage opportunity. Describe a strategy that would get you a free lunch. In this strategy, you can trade stock A, stock B, and the risk-free asset at the risk-free rate you computed in part (b). (Hint: What is the return on the minimum-variance portfolio of stocks A and B?) Q.4 _Keeping other things constant, what should the expected return on stock B in part (c) be so that there is no arbitrage opportunity? Assume that the CAPM holds and that the expected return on the market portfolio is E[Rm] = 0.07 and the standard deviation of market returns is om= 0.20. The correlation between the return on the market portfolio and the return on stock A is -0.05. The expected (CAPM) return on stock A is E[Ra] = 0.04 and the standard deviation of stock A's returns is on = 0.25. Q.1 What is the beta of stock A? Q.2What is the risk-free rate? Q.3There is also another stock, B. The observed (actual) return on stock B is E[RB] = 0.13, its standard deviation is OB = 0.55, its beta is Be = 0.14, and its returns are perfectly negatively correlated with returns on stock A (i.e., p = -1). Show that there is an arbitrage opportunity. Describe a strategy that would get you a free lunch. In this strategy, you can trade stock A, stock B, and the risk-free asset at the risk-free rate you computed in part (b). (Hint: What is the return on the minimum-variance portfolio of stocks A and B?) Q.4 _Keeping other things constant, what should the expected return on stock B in part (c) be so that there is no arbitrage opportunity

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