Question: Assume the rate of return on short term government securities (perceived to be risk-free) is five percent. Assume also that the expected rate of return required by the market for a portfolio with a beta of 1 is 12 percent. According to the CAPM:
[A] Calculate the expected rate of return on the market portfolio?
[B] Determine the expected rate of return on a stock with β = 0?
[C] Assume you consider buying a stock which does not pay a dividend. The current price is $50, and in one year, you expect the price to be 57.50 dollar, giving a rate of return of 15 percent. The stock has a β which you calculate to be 0.75. Suppose your estimate of the stock’s price in one year is correct, is the stock currently overpriced or underpriced according to the CAPM? Describe thoroughly, using the ideas and formulas we covered in lecture.