1)In 1997, the yield (or rate of return) on short-term government securities (perceived to be risk-free) was about 5%. Suppose the expected rate of return required by the market for a portfolio with a beta of 1.0 is 12%. According to the CAPM,

(a) What is the expected rate of return on the market portfolio?

(b) What would be the expected rate of return on a zero-beta stock?

(c) Suppose you consider buying a share of stock at a price of $40. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluated at = 0:5. Is the stock overpriced or underpriced?

2) Two fund managers are comparing performance. One averaged 19% return and the other a 16% return. However, the beta of the rst fund was 1.5, while that of the second was 1.0.

(a) Can you tell which fund manager was a better selector of individual stocks (aside from the issue of general movements in the market)?

(b) If the T-bill rate were 6% and the market return during the period were 10%, which manager would be the superior stock selector?

(c) What if the T-bill rate were 3% and the market return were 15%?