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Two stocks: need market risk premium, fair price, portfolio weights, equilibrium expected return.
Consider two stocks, A and B, with the following expected returns and betas
A 9.55% 0.80
B 10.98% 1.10
The risk free rate is 5.75%
a. Assuming that Stock A is priced according to the CAPM, What is the market risk premium?
b. What is the equilibrium expected return of Stock B?
c. Consider Stock C, which has a beta of 0.90. Suppose that you have forecast a return of 8.00% for Stock C. Is Stock C is overpriced, underpriced or fairly priced?
d. Suppose that you construct an arbitrage portfolio to exploit any mispricing that you might have found in Stocks A, B and C. What would the weights of this portfolio be?
e. Suppose that the risk free rate rises by 1%. What is the equilibrium expected return of Stock A?
This solution is comprised of questions related with corporate finance. Financial management risk premiums are determined.