10. The Capital Asset Pricing Model and the security market line Keith holds a portfolio that is invested equally in three stocks (wp = WA WI 1/3). Each stock is described in the following table: Stock Beta Standard Deviation Expected Return DET 0.7 25% 8.0% AIL 1.0 38% 10.0% INO 1.6 34% 13.5% An analyst has used market- and firm-specific information to make expected return estimates for each stock. The analyst's expected return estimates may or may not equal the stocks' required returns. The risk-free rate [n] is 6%, and the market risk premium [RPM] is 4%. Use the following graph with the security market line (SML) to plot each stock's beta and expected return. (Note: Click on the points on the graph to see their coordinates.) Ch 08- Assignment - Risk and Rates of Return 20 18 10 14 12 Stock DET Stock All Stock INO 0 02 04 04 14 1.6 1.8 20 0.8 1.0 1.2 RISK (Beta) A stock is in equilibrium if its required return its expected return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either undervalued or overvalued). Based on the analyst's expected return estimates, stock INO is stock AIL is in equilibrium, and stock DET is RATE OF RETURN (Percent) . 0 2 D 2 is less than O 02 04 0.6 0.8 1.0 12 RISK (Beta) equals is more than A stock is in equilibrium if its required return its expected return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either stock AIL is in equilibrium, and undervalued or overvalued). Based on the analyst's expected return estimates, stock INO is stock DET is 0 20 02 04 OG 0.8 1.0 12 14 16 18 RISK (Beta) A stock is in equilibrium if its required return its expected return. In gene (or fairly valued), but sometimes investors have different opinions about a stock's prospects undervalued or overvalued). Based on the analyst's expected return estimates, stock INO is stock DET is 20 in equilibrium undervalued overvalued markets and stocks are in equilibrium at a stock is out of equilibrium (either stock AIL is in equilibrium, and A stock is in (or fairly valu undervalued stock DET is in equilibrium undervalued overvalued RISK (Beta) required return; its expected return. In general, assume that markets and stocks are in equilibrium hes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either Jased on the analyst's expected return estimates, stock INO is stock AIL is in equilibrium, and