Suppose the market portfolio is equally likely to increase by 30% or decrease by 10%. Also suppose that the risk-free interest rate is 4%.
a. Use the beta of a firm that goes up on average by 40% when the market goes up and goes down by 20% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return?
b. Use the beta of a firm that goes up on average by 18% when the market goes down and goes down by 8% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return?