1. The risk-free rate is 6%. The expected rate of return on the stock market is 10%. What is the appropriate cost of capital for a project that has a beta of -2? Does this make economic sense?
2. Draw the SML if the true expected rate of return on the market is 6% per annum and the risk-free rate is 2% per annum. How would the figure look if you were not sure about the expected rate of return on the market?
3. A junk bond with a beta of 0.4 will default with 20% probability. If it does, investors receive only 60% of what is due to them. The risk-free rate is 3% per annum and the risk premium is 5% per annum. What is the price of this bond, its promised rate of return, and its expected rate of return?