Question 2 You plan to invest part of your savings and are examining the following data: Beta Expected return 2% 20% 9% 7% Yield to maturity on 10-year government bonds Stock A Stock B Stock C 1.3 1.1 0.5 Portfolio D 10% 1.0 (a) If only Portfolio D is correctly priced, are stocks A, B and C correctly priced? If not, what investment action would you recommend for each stock to take advantage of the price anomaly? (10 marks) (b) Company X has just paid a dividend of $0.20 per share. The company expects dividends to grow at 5% per annum for the foreseeable future. It is trading at $10 in the market. You feel that, given the risk of this company, your required return on this stock is 8%. Is the market assigning a lower or higher risk to this stock compared to its fair value? Appraise this observation in relation to the SML. (10 marks) (c) You currently hold a diversified portfolio of stocks. Your investment advisor urges you to invest in gold which has a beta of -0.5. How does gold's expected return compare to the risk-free rate, according to the CAPM? Appraise whether you should add gold to your existing portfolio and explain why or why not. (5 marks) Question 2 You plan to invest part of your savings and are examining the following data: Beta Expected return 2% 20% 9% 7% Yield to maturity on 10-year government bonds Stock A Stock B Stock C 1.3 1.1 0.5 Portfolio D 10% 1.0 (a) If only Portfolio D is correctly priced, are stocks A, B and C correctly priced? If not, what investment action would you recommend for each stock to take advantage of the price anomaly? (10 marks) (b) Company X has just paid a dividend of $0.20 per share. The company expects dividends to grow at 5% per annum for the foreseeable future. It is trading at $10 in the market. You feel that, given the risk of this company, your required return on this stock is 8%. Is the market assigning a lower or higher risk to this stock compared to its fair value? Appraise this observation in relation to the SML. (10 marks) (c) You currently hold a diversified portfolio of stocks. Your investment advisor urges you to invest in gold which has a beta of -0.5. How does gold's expected return compare to the risk-free rate, according to the CAPM? Appraise whether you should add gold to your existing portfolio and explain why or why not