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Compute the risk-free rate and the market risk premium

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Reference no: EM132855254

Question - Use CAPM to calculate stocks A and B have the following features:

The return standard deviation of the market portfolio is 18%.

Stock A has and expected return of 10% and a beta of 1.2, whereas

Stock B has an expected return of 15% and a beta of 2.

1. Assume that stocks A and B are correctly priced according to the CAPM

a. Compute the risk-free rate and the market risk premium.

b. Draw the security market line, and label stocks A and B, as well as the risk-free rate and the market portfolio on the plot. You are not required to draw the security market line to scale.

2. Consider stock C that has an expected return of 17%, a beta of 2.3, and a standard deviation of returns of 20%. According to the CAPM, is stock C overpriced, underpriced, or correctly priced? What would you recommend to investors?

Reference no: EM132855254

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