Suppose the rate of return on 3-month T-Bill is 4%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 0.8 is 12%. According to the capital asset pricing model:
(a) What is the expected rate of return on a portfolio with a beta of 1.5?
(b) Suppose you consider buying a share of stock A at $20. The stock is expected to pay $3 dividends next year and you expect it to sell then for $19. The stock risk has been evaluated at β = 0.5. Is the stock underpriced, overpriced, or fairly priced? How should you trade according to your own belief?
(c) Plot stock A on the SML graph.