A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. Therisk-free rate is 0.05 and the market expected rate of return is 0.09. Showwhether this security is underpriced, fairly priced or overpriced.1.The returns on share A follow the market model with coefficients aa = 0.01, Ba =1.25. If at time t, K MT = 0.02 and the actual return on share A is 0.025, calculateEAt (the error term).2.3.An investor invests 30 percent of his wealth in a risky asset with an expected rateof return of 0.15 and a variance of 0.04 and 70 percent in a risk-free asset with areturn of 0.06. Calculate the portfolio's expected return.4.Toyota stock has the following probability distribution of expected prices one yearfrom now:State Probability Price125%40%£502£60335%£70Currently, each share is priced at £55. Toyota will pay a dividend of £4 per shareat the end of the year. What is your expected holding-period return on Toyota?5.According to the Capital Asset Pricing Model (CAPM), what does beta measure?Explain briefly.

1) Expected return = 11% Beta = 1.5 Risk free rate (Rf) = 5% Market return (Rm) = 9%

1. A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. Show whether this security is underpriced, fairly priced or overpriced.

1. A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. Show whether this security is underpriced, fairly priced or overpriced.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter3: Risk And Return: Part Ii

Section: Chapter Questions

Problem 2Q: Security A has an expected rate of return of 6%, a standard deviation of returns of 30%, a...

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Concept explainers

Risk and return

Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.

Capital Asset Pricing Model

Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.

Question

A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The
risk-free rate is 0.05 and the market expected rate of return is 0.09. Show
whether this security is underpriced, fairly priced or overpriced.
1.
The returns on share A follow the market model with coefficients aa = 0.01, Ba =
1.25. If at time t, K MT = 0.02 and the actual return on share A is 0.025, calculate
EAt (the error term).
2.
3.
An investor invests 30 percent of his wealth in a risky asset with an expected rate
of return of 0.15 and a variance of 0.04 and 70 percent in a risk-free asset with a
return of 0.06. Calculate the portfolio's expected return.
4.
Toyota stock has the following probability distribution of expected prices one year
from now:
State Probability Price
1
25%
40%
£50
2
£60
3
35%
£70
Currently, each share is priced at £55. Toyota will pay a dividend of £4 per share
at the end of the year. What is your expected holding-period return on Toyota?
5.
According to the Capital Asset Pricing Model (CAPM), what does beta measure?
Explain briefly.

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