Stock	Expected return	Beta
K	20%	1.6
L	12%	0.9

6. Suppose we observe two stocks with the following characteristics: (9 marks)

a. An asset is said to be overvalued if its price is too high given its expected return and risk. The risk-free rate is currently 6%. Is one of the two stocks overvalued relative to the other? Explain your answer fully (i.e., provide reasons why you think the stock is or is not overvalued). (3.5 marks)

Stock	Expected return	Beta
M	20%	1.6
N	12%	0.9

b. Suppose we observe two stocks with the following characteristics:

An asset is said to be undervalued if its price is too low given its expected return and risk. The risk-free rate is currently 6%. Is one of the two stocks undervalued relative to the other? Explain your answer fully (i.e., provide reasons why you think the stock is or is not undervalued). (3.5 marks)

c. In a well-functioning, well-organized, active market, can a stock be persistently over- or undervalued relative to an average asset in the market? Explain why or why not. How and when is equilibrium achieved? (2 marks)