Suppose the rate of return on short-term government securities (perceived to be risk-free) is about 5%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 1 is 12%. According to the capital asset pricing model:

a. What is the expected rate of return on the market portfolio?

Expected Rate of Return %

b. What would be the expected rate of return on a stock with β = 0?

Expected Rate of Return %

c. Suppose you consider buying a share of stock at $40. The stock is expected to pay $3 dividends next year and you expect it to sell then for $41. The stock risk has been evaluated at β = –0.5. Is the stock overpriced or underpriced?

Overpriced

Underpriced