1. Why do we need to use beta to invest in a stock? How can you measure (or estimate) it? If a stock has a beta of 2.50, how do you define it?
2. Write down the CAPM equation. Define every part of it. Draw the graph properly. How does it help us in financial decision making?
3. Assume that you invest equal amounts in a portfolio with an expected return of 16 percent and a standard deviation of returns of 18 percent and a risk-free asset with an interest rate of 4 percent. Calculate the standard deviation of the returns on the resulting portfolio.
4. The beta of Wal-Mart is 0.65, the risk-free rate is 4 percent, and the expected market risk premium is 14 percent. Calculate the expected rate of return on this company.
5. You have stock YYY, which has following information: Beta = 0.75; risk-free rate = 4 percent; market rate of return = 12 percent. However, this stock actually gives 13 percent return. What should be the return of this stock? Is it underpriced or overpriced? How?