Suppose the market portfolio is equally likely to increase by 35% or decrease by 5%. Also suppose that the risk-free interest rate is 5%.
a. Use the beta of a firm that goes up on average by 50% when the market goes up and goes down by 10% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return?
b. Use the beta of a firm that goes up on average by 17% when the market goes down and goes down by 24% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return?