Assume the risk free rate is 2.0%

The SP500 is considered the market and is expected to return 12%

Today (T=0), you invest $400 in Stock A and $600 in Stock B to create Portfolio A,B

Assume there are no taxes or dividends

Stock A has a beta of 1.40 and Stock B has a beta of 0.60

Use the CAPM equation to estimate each stocks fair rate of return

You believe the stock market inefficient

o Your analysis shows Stock A will return 17.5%

o Your analysis shows Stock B will return 12.5%

1.Based on your analysis, Stock A is __________ and Stock B is _________.

Fill in the blanks.

a. overvalued ; undervalued

b. overvalued ; fairly valued

c. undervalued ; undervalued

d. fairly valued ; overvalued

e. undervalued ; overvalued

2.In class we looked at the historical returns for a AMD and PG. Based on what we learned about beta, Stock A most likely __________ and Stock B most likely _________. Fill in the blanks.

a) is a semiconductor company ; makes consumer staples

b) makes consumer staples ; makes consumer staples

c) makes consumer staples ; is a semiconductor company

d) is a semiconductor company ; is a semiconductor company

e) Not possible to determine without knowing the correlation between Stock A and Stock B

3.Which of the following statements is most likely TRUE:

I. The portfolios beta is 0.92

II. To find the portfolios return, take the weighted average return of Stocks A & B

III. To find the portfolios total risk, take the weighted average of Stocks A & B standard deviation of returns

a. I b. II c. III d. I,III e. All of the statements