Homework Answers
expected/required return=risk free rate+beta*Market Risk Premium
1.
From 1:
8%=rf+0.8*MRP
10%=rf+1.8*MRP
=>MRP=2%
and rf=6.4%
Rm=8.4%
2.
Expected return on asset=6.4%+1.5*2%
=9.4%
3.
Expected return should be=6.4%+1.2*2%=8.8%
As actual expected return is higher, the stock is undervalued
Buy R1 worth 1 and invest 0.2 at risk free rate
Short 1.2 in market
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