1) Consider the following expectations for the market and two stocks in two possible equally likely states: State  Market return  Stock A   Stock B  Boom  25% 38% 12% Recession  5% -2% 6%   a. What is the expected return on each stock? b.  Given that the risk-free rate is 6%, draw the Security Market Line (SML) for this economy, and plot the two securities on the graph given that you have computed Stock A has a β of 2 and Stock B has a β of 0.3. c.   Assuming that the CAPM holds, state for each of the two stocks if the stock is overvalued, correctly priced, or undervalued according to CAPM?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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1) Consider the following expectations for the market and two stocks in two possible equally likely states:

State  Market return  Stock A   Stock B 
Boom  25% 38% 12%
Recession  5% -2% 6%
 


a. What is the expected return on each stock?

b.  Given that the risk-free rate is 6%, draw the Security Market Line (SML) for this economy, and plot the two securities on the graph given that you have computed Stock A has a β of 2 and Stock B has a β of 0.3.

c.   Assuming that the CAPM holds, state for each of the two stocks if the stock is overvalued, correctly priced, or undervalued according to CAPM?

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