Consider a small simple world where there are only two risky assets A and B, and a risk free asset f. In the market the two risky assets are equal in supply, so that the market portfolio is given by M = (A + B)/2. Risky assets are possibly correlated. a. Write down the expressions for the variance of the market returns and for the covariance between the returns of A and M, and hence derive the expression of the beta of A. (4 Marks) Now suppose further that the variance of A is 0.04, and the variance of B is 0.02. Also, the covariance between A and B is 0.01, the risk free rate is 0.1, and the market return is 0.22. b. Assuming that CAPM holds, find the expected returns for stock A and B. (3 Marks) Consider a small simple world where there are only two risky assets A and B, and a risk free asset f. In the market the two risky assets are equal in supply, so that the market portfolio is given by M = (A + B)/2. Risky assets are possibly correlated. a. Write down the expressions for the variance of the market returns and for the covariance between the returns of A and M, and hence derive the expression of the beta of A. (4 Marks) Now suppose further that the variance of A is 0.04, and the variance of B is 0.02. Also, the covariance between A and B is 0.01, the risk free rate is 0.1, and the market return is 0.22. b. Assuming that CAPM holds, find the expected returns for stock A and B