Consider the estimation of the CAPM and the Fama-French three-factor model: rit rf t = i + i(rM t rf t) + it, rit rf t = i + i(rM t rf t) + siSMBt + hiHMLt + it. You analyze a stock, run the Fama-French regression above, and obtain the following estimates: i = 0.5%, i = 1.3, si = 0.3, and hi = 0.5. Suppose that regardless of which model you use, you obtain the same estimate for i . In particular, assume that the stocks sensitivity to the market risk, i , is the same in both the CAPM and the Fama-French model. Assume that E[rM trf t] = 8%, E[SMBt ] = 4%, E[HMLt ] = 6%, and the current risk-free interest rate rf = 3%.

a) What is the required rate of return on the stock if the Fama-French model holds? What is the expected rate of return on the stock?

b) What is the required rate of return on the stock if the CAPM holds?

c) Explain the reasons for the difference between the stocks required rates of return in the CAPM and the Fama-French model. d) Suppose that the expected rate of return on the stock is the same as your answer in a). Compute the stocks alpha in the CAPM. e) Would you buy this stock if you believe in the CAPM? Would your answer be different if you believed in the Fama-French model instead?