QUESTION ONE

The estimated rates of return, beta coefficients and standard deviations of some securities are as given below:

Security

Estimated returns%

Beta

Standard deviation%

A

35

1.60

50

B

28

1.40

40

C

21

1.10

30

D

18

0.90

25

E

15

0.75

20

F

12

0.60

18

The risk-free rate is 10%. The market return is expected to be 25%

Required:

Determine which of the above securities are overpriced and which are underpriced(5mks)

CAPM postulates the nature of the relationship between the expected return and the systematic risk of security. Briefly, justify this statement.(5mks)