A stock that currently trades at $10 has a beta of 1.6. The risk-free interest rate for the is 10%, and the market price of risk is expected to be 5%.
a. What is the required rate of return on the stock?
b. Demonstrate graphically the disparity between the required return and the expected return on the stock, if that expected return is 20%. (Hint: Use the SML)
c. Explain the forces that can be expected to bring the market back into equilibrium.