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problem: In today's market, the risk-free rate of interest is 5 percent, & the S&P 500 index is returning 13 percent. The stock of Sludge-R-Us Corporation ("the recycling company") has a beta of 0.50 and the beta of Leech Pharmaceuticals Corporation stock ("gets the poison out fast") is 1.20. Investors expect a 10% rate of return from Sludge-R-Us and a 15 percent rate of return from Leech Pharmaceuticals.


[A] prepare the equation of the security market line (SML) using the data from today's market.

[B] What rate of return should investors require from Sludge-R-Us stock?

[C] Is Sludge-R-Us an aggressive or defensive investment? How do you conclude this? What does this mean?

[D] If the stock market fell by 20%, what would happen (on average) to Leech Pharmaceuticals stock?

[E] Consider a portfolio of $30,000 Sludge-R-Us and $10,000 Leech Pharmaceuticals.

    (a) find out the expected rate of return of this portfolio?

    (b) find out the beta of this portfolio?

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