As an equity analyst, you have developed the following

return forecasts and risk estimates for two different

investment funds (Fund T and Fund U):

Forecasted return % CAPM beta

Fund T 9.0 1.2

Fund U 10.0 0.8

a

If the risk-free rate is 4 per cent and the expected

market risk premium is 6 per cent, calculate the

expected return for each fund according to the CAPM.

b

Using the estimated expected returns from Problem a

along with your own return forecasts, demonstrate

whether Fund T and Fund U are currently priced to fall

directly on the security market line (SML), above the

SML or below the SML. According to your analysis, are

Funds T and U overvalued, undervalued or fairly valued?