Problem 2

You expect a risk-free rate (RFR) of 10 percent and a market return (Rm) of 14 percent. Compute the expected return for the following stocks and plot them on an SML graph.

Stock	Beta	E(Ri)
U	0.85
N	1.25
D	-0.20

You ask a stockbroker what the firms research department expects for these three stocks. The broker responds with the following information:

Stock	Current Price	Expected Price	Expected Dividend
U	22	24	0.75
N	48	51	2.00
D	37	40	1.25

Plot your estimated returns on the graph from part (a) and indicate what actions you would take with regard to these stocks. Explain your decisions.