Consider a CAPM economy where stocks A and B have the following features: • Stock A has and expected return of 10% and a beta of 1

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Consider a CAPM economy where stocks A and B have the following features: • Stock A has and expected return of 10% and a beta of 1.2, whereas • Stock B has an expected return of 15% and a beta of 2. The return standard deviation of the market portfolio is 18%. a) Assume that stocks A and B are correctly priced according to the CAPM i. Compute the risk-free rate and the market risk premium. (4 Marks) ii. Draw the security market line, and label stocks A and B, as well as the risk-free rate and the market portfolio on the plot. You are not required to draw the security market line to scale. (6 Marks) b) Consider stock C that has an expected return of 17%, a beta of 2.3, and a standard deviation of returns of 20%. According to the CAPM, is stock C overpriced, underpriced, or correctly priced? What would you recommend to investors? (4 Marks) c) What does the tangent portfolio represent in a CAPM economy? What is the condition that ensures this? (8 Marks) d) Describe what the buck for the bang ratio represents. Explain why it is the same for each asset in the tangent portfolio. (8 Marks)