TO CONCEPT C H E C K S Therefore (eP) 15.8 3. a. Total market capitalization is 3,000 1,940 1,360 6,300. Therefore, the mean excess return of the index portfolio is 3,000 1,940 1,360 6,300 10 6,300 2 6,300 17 10   b. The covariance between stock B and the index portfolio equals   Cov(RB, RM) B 2 .2 252 125   c. The total variance of B equals   2     2 2 2 B Var( B , RM eB) B M (eB)   Systematic risk equals 2 2 = .22 252 = 25. B M Thus the firm-specific variance of B equals   2(eB) 2 2 2 302 .22 252 875 B B M   4. The CAPM is a model that relates expected rates of return to risk. It results in the ex- pected return-beta relationship, where the expected risk premium on any asset is proportional to the expected risk premium on the market portfolio with beta as the proportionality constant. As such the model is impractical for two reasons: (i) ex- pectations are unobservable, and (ii) the theoretical market portfolio includes every risky asset and is in practice unobservable. The next three models incorporate addi- tional assumptions to overcome these problems. The single-factor model assumes that one economic factor, denoted F, exerts the only common influence on security returns. Beyond it, security returns are driven by independent, firm-specific factors. Thus for any security, i,   ri ai biF ei   The single-index model assumes that in the single-factor model, the factor F is per- fectly correlated with and therefore can be replaced by a broad-based index