EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
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Chapter 3.A, Problem A.4P
a)
Summary Introduction
To determine: The risk premium.
Introduction:
Risk premium is the difference of investment return and risk free
b)
Summary Introduction
To determine: Security’s market price.
Introduction:
The price at which the goods or securities are sold in the market is market price.
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Expected return
a) Suppose the risk-free rate is 1% and the expected rate of return on the market portfolio is 10%. In your view, the expected rate of return of a security is 12.2%. Given that this security has a beta of 1.4, do you consider it to be overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model? Please provide the details of your calculations and discuss your results
a) Suppose the risk-free rate is `X'% and the expected rate of return on the market portfolio is 10%. In your view, the expected rate of return of a security is 12.2%. Given that this security has a beta of 1.4, do you consider it to be overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model? Please provide the details of your calculations and discuss your results.
b) Using a graph, explain when a security is overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model. Plot your answer from (a) onto this graph.
Chapter 3 Solutions
EBK CORPORATE FINANCE
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?arrow_forwardplease help with this questionarrow_forwardUnder-valued or over-valuedarrow_forward
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- Suppose that the relevant equilibrium model is the CAPM with unlimited borrowing and lending at a riskless rate of interest. Assuming, you discovered a security that was located below the security market line. What would you conclude about the pricing of this particular security? Describe any changes you would expect to occur in its price.arrow_forwardSuppose you observe the following situation: Security Beta Expected Return Peat Company 1.70 13.60 Re - Peat Company 0.85 10.80 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk - free rate?arrow_forwardThe risk-free rate and the expected market rate of return and 0.056 and 0.125. Using the CAPM model, the expected rate of return of a security, that you are interested in, has a beta of 1.25 would be equal to Calculate the expected rate of returnarrow_forward
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