Assume that stock P has a standard deviation of 50% and its correlation with the market is 0.8. The market’s standard deviation is 20%. The Market Risk Premium (Rm-Rf) is 7% and the risk free rate is 5%
1. What would be the beta of stock P?
2. What would be its return of stock P as predicted by the CAPM?
3. If the stock has an actual return of 18%, what is the alpha of this stock?
4. Is it under or over-valued? What would you do with this stock (sell/buy)?
5. Assume that you run a regression using CAPM to obtain the beta of stock P. The R2 of the regression is 0.4. How would you interpret this result?