Question 3

(a) Assume that the risk-free rate of interest is 6% and the expected rate of return on the market is 16%. A share of stock sells for R50 today. It will pay a dividend of R6 per share at the end of the year. Its beta is 1.2. What do investors expect the stock to sell for at the end of the year?

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(b)Are the following true or false? Explain your answer.

(i) Stocks with a beta of zero offer an expected rate of return of zero.

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(ti) The CAPM implies that investors require a higher return to hold highly volatile securities.

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(iii)You can construct a portfolio with a beta of 0.75 by investing 0.75 of the investment

budget in bills and the remainder in the market portfolio.

(iv) CAPM says that all risky assets must have positive risk premium.

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(v) The expected return on an investment with a beta of 2.0 is twice as high as the expected return on the market.

(vi) If a stock lies below the security market line, it is under-valued.