Question 1 a. You are presented with the following graph: Why is portfolio A plotted below the Capital Market Line? Sketch this graph on your answer paper and mark on the graph portfolio A’s level of systematic and unsystematic risk. Explain your answer. (6 marks) b. You are presented the following graph: Why is security B plotted below the Security Market Line? Derive the SML equation and explain why we use beta as a measure of risk in the CAPM. (9 marks) c. Assume that the following assets are correctly priced according to Security Market Line (SML): Security 1 Security 2 E(R1) = 5% E(R2) = 10% Beta1 = 0.5 Beta2 = 1.5 What is the risk free-rate, market risk premium and the equation of the SML? (5 marks) Page 5 of 7 d. Portfolio A has beta of 0.76 and the correlation with the market portfolio 0.82. If the standard deviation of the market is 12%, what is the standard deviation of Portfolio A? Answer explaining the link between beta and correlation coefficient. (5 marks)