In a hypothetical market

r(j)

Beta(j)

Asset 1

6%

0.8

Asset 2

10%

1.8

where r(j)= expected return of asset j; beta(j)=beta coefficient of asset j.

a. Based on the information from the table above, derive the Security Market Line (SML) (5 points)

b. Suppose that there is a third asset. Beta(3)= 2. Yahoo Finance reports that the average rate of return is 9%. What is the predicted return according to CAPM? (3 points)

c. Is the asset overpriced or underpriced? (2 points)