Expected returns and risk in portfolio.

When the CAPM holds with E (RM) =12%, σM = 20%, and Rf = 2%,

(a) What should be expected return of stock X that has a standard deviation σX = 30%, and a correlation with the market portfolio of ρXM = 0.6.

(b) Assume that stock Y has the same standard deviation as stock X, i.e., σy = 30%, but the correlation with the market portfolio ρYM = 0.2. Compute βY and E (RY). What can you learn by comparing results in (a) and (b)?

(c) A portfolio p of consisting 60% of stock X and 40% of stock Y, has a correlation ρpM = 0.62 with the market. What is the portfolio volatility? Statement on the diversification effect.