Question

Suppose the yield on short-term government securities (perceived to be risk-free) is about 5%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 15.0%. According to the capital asset pricing model: a. What is the expected return on the market portfolio? (Round your answer to 1 decimal place.) Expected rate of return ſ b. What would be the expected return on a zero-beta stock? Expected rate of return % Suppose you consider buying a share of stock at a price of $60. The stock is expected to pay a dividend of $7 next year and to sell then for $63. The stock risk has been evaluated at ß = -0.5. C-1. Using the SML, calculate the fair rate of return for a stock with a ß = -0.5. (Round your answer to 1 decimal place.) Fair rate of return %

Answer 1

a. Expected Return of stock using CAPM =Risk Free Rate+Beta*(Market return-Risk Free Rate) =5%+1*(15%-5%) =15%

b. Expected Return of 0 beta stock =5%+0*(15%-5%) =5%

c-1 Fair return of stock =Risk Free Rate+Beta*(Market Return-Risk Free Rate) =5%-0.5*(15%-5%) =0%

c-2 Expected Return =(Price next year -Price today+Dividend Next Year)/Price today=(63-60+7)/60 =16.67%

c-3 Since expected rate is higher than fair return hence stock is underpriced.