Problems for Lecture 7 1. Security B has a price of $60 and a beta of 1.25. The risk-free rate is 1% and the market risk premium is 4%. (a) According to the CAPM, what return do investors expect on the security? (b) Investors expect the security not to pay any dividend next year. At what price do investors expect the security to trade next year? (c) At what price do investors expect the security to trade next year, if the expected dividend next year is $2 instead of zero? 2. Consider the following table which gives a security analyst's expected return on two stocks for two particular market returns: Market Return DangerCo. SteadyCo. -8% -18% -2% 12% 22% 8% (a) What are the betas of the two stocks? (b) What is the expected rate of return on each stock if both market outcomes are equally likely? (c) Draw the SML for this economy if the T-bill rate is 1%. (d) Plot the two securities on the SML graph. What are the alphas of each? Problems for Lecture 7 1. Security B has a price of $60 and a beta of 1.25. The risk-free rate is 1% and the market risk premium is 4%. (a) According to the CAPM, what return do investors expect on the security? (b) Investors expect the security not to pay any dividend next year. At what price do investors expect the security to trade next year? (c) At what price do investors expect the security to trade next year, if the expected dividend next year is $2 instead of zero? 2. Consider the following table which gives a security analyst's expected return on two stocks for two particular market returns: Market Return DangerCo. SteadyCo. -8% -18% -2% 12% 22% 8% (a) What are the betas of the two stocks? (b) What is the expected rate of return on each stock if both market outcomes are equally likely? (c) Draw the SML for this economy if the T-bill rate is 1%. (d) Plot the two securities on the SML graph. What are the alphas of each