Problem 4: (12 marks)

A security analyst has forecasted returns on the market portfolio and shares of RIM under three different economic conditions for next year:

Return on Return on

State of the economy Probability Market RIM

Boom 35% 55%

Moderate Growth 11% 13%

Recession -6% -14%

1. Calculate the expected returns on the market portfolio. (2pts)

2. Calculate the beta for RIM, assume the expected return for RIM is 16.75%. (6pts)

3. Assuming the risk-free rate is 6%:
   1. Calculate the market risk premium (1pt)
   2. According to the CAPM, what is the required return for RIM? Compare this to the expected return of RIM (expected return is 16.75%). What is the implication of your finding? (3pts)