1. An analyst has modeled XYZ stock using the Fama & French three factor model (FF3FM). Over the past few years the risk premium on SMB was 2.25% and the risk premium on HML was 2.95%. Regression analysis shows that XYZ’s beta coefficient on SMB is 2.5 and on HML is -1.95. If the risk–free rate is 1.75%, the market risk premium is 5.75%, and XYZ’s market beta is 2.0, what is a fair rate of return on XYZ according to the FF3FM?
2. Using the data from problem 1, if you forecasted an expected return of 14.00% for stock XYZ, is it overvalued, undervalued, or fairly valued? Briefly, why?