The risk-free rate is 8% and the expected rate of return on the market portfolio is 13%. a. Calculate the required return of a security with a beta of 1.13 and an expected rate of return of 16%. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Required return % b. Is the security overpriced or underpriced? Underpriced Explanation: a. Required return = rf + β(rm − rf) = 8% + [1.13 × (13% − 8%)] = 13.65% Expected return = 16% b. The security is underpriced. Its expected return is greater than the required return given its risk.

The risk-free rate is 8% and the expected rate of return on the market portfolio is 13%.

a.	Calculate the required return of a security with a beta of 1.13 and an expected rate of return of 16%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Required return

%

b.	Is the security overpriced or underpriced?
	Underpriced

Explanation:

a.

Required return = rf + β(rm − rf) = 8% + [1.13 × (13% − 8%)] = 13.65%

Expected return = 16%

b.

The security is underpriced. Its expected return is greater than the required return given its risk.

The investment opportunities have these characteristics:

The investment opportunities have these characteristics:

	Mean Return	Standard Deviation
Stocks	18.40%	13.40%
Bonds	12.00%	4.29%
Portfolio	16.48%	8.09%

The best choice depends on the degree of your aversion to risk. Nevertheless, we suspect most people would choose the portfolio over stocks since the portfolio has almost the same return with much lower volatility. This is the advantage of diversification.

A stock will provide a rate of return of either −27% or +35%.

a.	If both possibilities are equally likely, calculate the expected return and standard deviation. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Expected return	%
Standard deviation	%

b.	If Treasury bills yield 4% and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be?

Market risk

$

Explanation:

a.

The expected rate of return on the stock is 4.0%. The standard deviation is 31.0%.

b.

Because the stock offers a risk premium of zero (its expected return is the same as the expected return for Treasury bills), it must have no market risk. All the risk must be diversifiable, and therefore of no concern to investors.