Question: The risk free rate is 4%. The expected return on the market portfolio is 15%. Stock A has a beta of 0.7 and an expected

The risk free rate is 4%. The expected return on the market portfolio is 15%. Stock A has a beta of 0.7 and an expected return of 10%. Stock B has a beta of 1.5 and an expected return of 20%. Answer the following questions:

A. Draw the security market line. Label all relevant points (expected returns and betas of the risk free asset and the market portfolio).

B. Is stock A fairly priced, according to the CAPM? Why or why not.

C. Indicate where stock B lies on the graph from part A.

D. Is stock B fairly priced, according to the CAPM? Why or why not?

E. Indicate where stock B lies on the graph from part a.

F. If you are an active portfolio manager, how do you trade in these two stocks? Explain your answer.

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