Question 2 Part II – CAPM: (5 points) We saw in class that the CAPM relates risk to expected returns for every security in the market , amp; Risk in…

Question 2 Part II – CAPM: (5 points)

We saw in class that the CAPM relates risk to expected returns for every security in the market, & Risk in CAPM is covariance. Suppose I told you that the relationship between risk and return given by the security market line was linear. That is, for any security x:

E(Rx)=a+b.σMx.

Use just this information to derive the CAPM equation/formula. (Hint: Two securities/portfolios that lie on the security market line are the risk-free asset & the market).