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Consider the following expected returns and betas for two stocks in the economy: Stock A: Expected return = 18% Beta = 2 Stock B: Expected return =...
Consider the following expected returns and betas for two stocks in the economy:
Stock A: Expected return = 18% Beta = 2
Stock B: Expected return = 9% Beta = 0.3
a. Given that the risk-free rate is 6% and the expected market return is 15%, draw the Security Market Line (SML) for this economy, and plot the two securities on the graph.
b. Assuming that the CAPM holds, by how many percentage points are the securities located above or below the security market line? State for each of the two stocks if the stock is overvalued, correctly priced, or undervalued according to CAPM?
