1) Assume a fictitious world where there are four stocks:

General Electric (GE)

CitiGroup (C)

British Petroleum (BP)

FaceBook (FB)

The market is in equilibrium where CAPM assumptions hold (e.g. homogeneous expectations, efficient markets, zero transaction costs, etc.)

Express the equilibrium condition for this universe of stocks in terms of each stock’s return contribution and risk contribution. For notation purposes, you can use the symbols rmkt & σmkt to represent the market’s return & risk and rf to represent the risk-free rate. (Note: Students can either type or neatly hand-write the relationship and upload a picture or file containing the expression.)

2) Assume a fictitious world where there are four stocks:

General Electric (GE)

CitiGroup (C)

British Petroleum (BP)

FaceBook (FB)

The market is in equilibrium where CAPM assumptions hold (e.g. homogeneous expectations, efficient markets, zero transaction costs, etc.)

Describe in words, the equilibrium relationship from Question #2 above.

3) Assume a fictitious world where there are four stocks:

General Electric (GE)

CitiGroup (C)

British Petroleum (BP)

FaceBook (FB).

The market is in equilibrium where CAPM assumptions hold (e.g. homogeneous expectations, efficient markets, zero transaction costs, etc.)

What would be the market’s response if the ratio of the contribution to the market’s risk premium divided by the contribution to the market’s variance is higher for BP and lower for FB vs. the other two stocks?