5. The capital asset pricing model

Charles holds a portfolio that is invested equally in three stocks. An analyst has used market- and firm-specific information to make expected return estimates for each stock. Each stock is described in the following table:

Stock	Beta	Expected Return
PPQ	1.4	16%
RRT	0.4	8%
WYY	1.2	14%

The risk-free rate, Rf, is 8 percent and the market return, Rm is 13 percent. The line given on the following graph represents the security market line (SML), which is derived from the CAPM equation: Rj=Rf+Bj(RmRf). Draw a graph with the security market line and plot each stocks beta and expected return.

Sometimes investors have different opinions about a stocks prospects and may think that a stock is either undervalued or overvalued.

Determine the required rate of return for each stock, and then use the analysts expected return estimates to determine whether he thinks each stock in Charless portfolio is undervalued, overvalued, or fairly valued.

Stock	Required Rate of Return	Valuation (Fairly valued, overvalued, undervalued)
	(Percent)
PPQ	_____%	___________
RRT	_____%	___________
WYY	_____%	___________