Problem 7-25

Suppose the yield on short-term government securities (perceived to be risk-free) is about 5%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 8.0%. According to the capital asset pricing model:

a.	What is the expected return on the market portfolio?(Round your answer to 1 decimal place.)

Expected rate of return

%

b.	What would be the expected return on a zero-beta stock?

Expected rate of return

%

Suppose you consider buying a share of stock at a price of $100. The stock is expected to pay a dividend of $9 next year and to sell then for $103. The stock risk has been evaluated at = .5.

c-1.	Using the SML, calculate the fair rate of return for a stock with a = 0.5.

Fair rate of return

%

c-2.	Calculate the expected rate of return, using the expected price and dividend for next year.(Round your answer to 2 decimal places.)

Expected rate of return

%

c-3.	Is the stock overpriced or underpriced?
	Underpriced Overpriced