1. "What would you recommend to an investor who is considering an investment which, according to its beta, plots below the security market line (SML)? "

Invest; return is high relative to risk.

Don't invest; risk is high relative to return.

Invest; stocks revert to the SML over time.

Don't invest; stocks below the SML have too much unique risk.

2. "A company you are researching has common stock with a beta of 1.25. Currently, Treasury bills yield 4%, and the market portfolio offers an expected return of 13%. The company finances 20% of its assets with debt that has a yield to maturity of 6%. The firm also uses preferred stock to finance 30% of its assets. The preferred stock has a current price of $10 per share and pays a level $1.00 dividend. The firm is in the 35% tax bracket. What is the weighted average cost of capital?"

12.76%

11.41%

15.97%

13.62%

19.40%