Question 3 (14 points; CAPM)

ANSWER THE FOLLOWING QUESTION

The following information describes the expected return and risk relationship for the stocks of two of WAH's competitors.

Stock X 12.0% 20% 1.3

Stock Y 9.0 15 0.7

Market Index 10.0 12 1.0

Risk-free rate 5.0

Using only the data shown in the preceding table:

a. (4 points) Draw and label a graph showing the security market line, and position Stocks X and Y relative to it.

b. (4 points) Compute the alphas both for Stock X and for Stock Y. Show your work.

c. (6 points) Assume that the risk-free rate increases to 7 percent, with the other data in the preceding matrix remaining unchanged. Select the stock providing the higher expected risk adjusted return and justify your selection. Show your calculations.