9. Assume that the Risk Free rate is 3% and the Expected Return on the market is 7%. Show if these stocks
are under, over, or fairly valued. Illustrate it in a chart with the SML and the expected returns of the
stocks.
CAPM returnasset = RiskFree + [E(Rmarket)- Risk Free] \cdot \beta_{asset} i
Security
Over/Under
E(Return) Beta CAPM Return Valued?
Stock W 0.075 0.85
Stock X 0.09 0.95
Stock Y 0.12 1.2
Stock Z 0.105 1.1
Show (and explain) your results in the following chart.
0.13
0.12
0.11
CAPM Return
E(Return)
0.09
0.08
0.07
0.8
0.85
0.9
0.95
1
1.05
1.1
1.15
1.2
1.25
a. What would happen with the undervalued assets? Why?
b. What would happen with the overvalued assets? Why?
c. What would happen with fair valued assets? Why?
