Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 6.0%. According to the capital asset pricing model:

What is the expected return on the market portfolio?

What would be the expected return on a zero-beta stock?

Suppose you consider buying a share of stock at a price of $55. The stock is expected to pay a dividend of $6 next year and to sell then for $57. The stock risk has been evaluated at β = 0.5

Using the SML, calculate the fair rate of return for a stock with a β = 0.5.

Calculate your expected rate of return for the stock with a β = 0.5, using the expected price and dividend for next year.

Is the stock overpriced or underpriced?

a. Underpriced
b. Overpriced