Problem
Suppose the rate of return on short-term government securities (perceived to be risk-free) is about 8%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 1 is 16%. According to the capital asset pricing model:
• What is the expected rate of return on the market portfolio?
• What would be the expected rate of return on on a stock with β = 0?
Suppose you consider buying a share of stock at $57. The stock is expected to pay $3.5 dividends next year and you expect it to sell then for $60. The stock risk has been evaluated at β = -.5. Is the stock overpriced or underpriced?