Priced to fall directly on the security market

Question

1. As an equity analyst, you have developed the following return forecasts and risk esti- mates for two different stock mutual funds (Fund T and Fund U):

	Forecasted Return	CAPM Beta
Fund T	9.0%	1.20
Fund U	10.0	0.80

1.  

   1. If the risk-free rate is 3.9 percent and the expected market risk premium (i.e., E ( R _M ) − RFR ) is 6.1 percent, calculate the expected return for each mutual fund according to the CAPM.

   2. Using the estimated expected returns from Part a along with your own return forecasts, demonstrate whether Fund T and Fund U are currently priced to fall directly on the security market line (SML), above the SML, or below the SML.

   3. According to your analysis, are Funds T and U overvalued, undervalued, or properly valued?