Suppose the rate of return on short-term government securities (perceived to be

Question

Suppose the rate of return on short-term government securities (perceived to be risk-free) is about 7%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of I is 13%. According to the capital asset pricing model: a. What is the expected rate of return on the market portfolio? (Round your answer to 2 decimal places. Omit the %sign in your response.) Expected rate of return % b. What would be the expected rate of return on a stock with 3 = O? (Round your answer to 2 decimal places. Omit the W sign in your response.) Expected rate of return % c. Suppose you consider buying a share of stock at $45. The stock s expected to pay $3 dividends next year and you expect it to sell then for $46. The stock risk has been evaluated at 13 = -.5. Is the stock overpriced or underpriced? Overpriced Underpriced

Explanation / Answer

a)Rs = Rf + [beta * (Rm-Rf) ]

       = 7 + [1 * (13 -7 )]

       = 7 + [1 * 6]

      = 7 +6 = 13%

b)Expected return = 7 + [0*(13-7) ]

                           = 7 +0 = 7%

c)Underpriced .

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