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    Expected and Required Rates of Return

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    (6-13): Historical Returns: Expected and Required Rates of Return

    You have observed the following returns over time:

    Year Stock X Stock Y Market
    2003 14% 13% 12%
    2004 19 7 10
    2005 216 25 212
    2006 3 1 1
    2007 20 11 15

    Assume that the risk-free rate is 6% and the market risk premium is 5%.

    a. What are the betas of Stocks X and Y?

    b. What are the required rates of return for Stocks X and Y?

    c. What is the required rate of return for a portfolio consisting of 80% of Stock X
    and 20% of Stock Y?

    d. If Stock X's expected return is 22%, is Stock X under- or overvalued?

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    The solution explains how to calculate the expected and required rates of return.

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