Task: Consider two stocks, A and B, with the following expected returns and betas
Expected
Return Beta
A 9.55% 0.80
B 10.98% 1.10
The risk free rate is 5.75%
Q1. Assuming that Stock A is priced according to the CAPM, What is the market risk premium?
Q2. What is the equilibrium expected return of Stock B?
Q3. Consider Stock C, which has a beta of 0.90. Suppose that you have forecast a return of 8.00% for Stock C. Is Stock C is overpriced, underpriced or fairly priced?
Q4. Suppose that you construct an arbitrage portfolio to exploit any mispricing that you might have found in Stocks A, B and C. What would the weights of this portfolio be?
Q5. Suppose that the risk free rate rises by 1%. What is the equilibrium expected return of Stock A?