Question: QUESTION THREE ( 10 POINTS) An analyst expects a risk-free return of 4.5 percent, a market return of 14.5 percent, and the returns for Stocks

QUESTION THREE ( 10 POINTS)

An analyst expects a risk-free return of 4.5 percent, a market return of 14.5 percent, and the returns for Stocks A and B that are shown in the following table.

Stock	Beta	Analysts Estimated Return
A	1.2	16%
B	0.8	14%

(a) Draw a graph and plot the risk free, market risk and beta values?

(1) Where Stock A and B would plot on the security market line (SML) if they were fairly valued using the capital asset pricing model (CAPM)

(2) Where Stock A and B actually plot on the same graph according to the returns estimated by the analyst and shown in the table

(b) State whether Stock A and B are undervalued or overvalued if the analyst uses the SML for strategic investment decisions.

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