a. Stock XYZ has an expected return of 12% and risk of = 1.0. Stock ABC

a. Stock XYZ has an expected return of 12% and risk of β = 1.0. Stock ABC is expected to return 13% with a beta of 1.5. The market’s expected return is 11% and r_f = 5%. According to the CAPM, which stock is a better buy? What is the alpha of each stock? Plot the SML and the two stocks and show the alphas of each on the graph.

b. The risk-free rate is 8% and the expected return on the market portfolio is 16%. A firm considers a project with an estimated beta of 1.3. What is the required rate of return on the project? If the IRR of the project is 19%, what is the project alpha?