Suppose the yield on short-term government securities (perceived to be risk-free

Question

Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 8.0%. 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 % 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 $70. The stock is expected to pay a dividend of $9 next year and to sell then for $73. The stock risk has been evaluated at = –.5. c-1. Using the SML, calculate the fair rate of return for a stock with a = –0.5. Fair rate of return % c-2. Calculate the expected rate of return, using the expected price and dividend for next year. (Round your answer to 2 decimal places.) Expected rate of return % c-3. Is the stock overpriced or underpriced? Underpriced Overpriced

Explanation / Answer

a) Exp return= 4%+1*(8%-4%) 8% b) Exp return= 4%+0*(8%-4%) 4% c) Purchase price 70 Dividend 9 Selling price 73 Beta -0.5 (9+(73-70))/70 17.14% 12 (70*17.14%) Exp stock price 82 Stock is under priced

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