Currently the risk-free rate equals 5% and the expected return on the market portfolio equals

11%.

An investment analyst provides you with the following information:

Stock

Beta

Expected Return

A

1.33

12%

B

0.70

10%

C

1.50

14%

D

0.66

9%

a.

Indicate whether each stock is overpriced, underpriced, or correctly priced.

b.

For each stock, subtract the risk-

free rate from the stock's expected return and divide the

result by the stock's beta.

For example, for asset A this calculation is (12% 5%) 1.33.

Provide an interpretation for these ratios.

Which stock has the highest ratio and which has the

lowest?

c.

Show how a smart investor could construct a portfolio of stocks C and D that would

outperform stock A.

d.

Construct a portfolio consisting of some combination of the market portfolio and the risk-free

asset such that the portfolio's expected return equals 9%.

What is the beta of this portfolio?

What does this say about stock D?

e.

Divide the risk premium on stock C by the risk premium on stock D.

Next, divide the beta of

stock C by the beta of stock D.

Comment on what you find.