Computation of the expected rate of return using capm

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Computation of the expected rate of return using CAPM.

Suppose the rate of return on short-term government securities (perceived to be risk-free) is 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 CAPM-

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

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

c) [Challenge Question] Suppose you consider buying a stock which does not pay a dividend. The current price is $50, and in one year, you expect the price to be $57.50, giving a rate of return of 15%. The stock has a β which you calculate to be 0.75. Assuming your estimate of the stock's price in one year is correct, is the stock currently overpriced or under-priced according to the CAPM? Explain thoroughly, using the ideas and formulas we covered in lecture.

Reference no: EM1311088

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