Question

Wilson holds a portfolio that invests equally in three stocks (wAwA = wBwB = wCwC = 1/3). Each stock is described in the following table:

Stock	Beta	Standard Deviation	Expected Return
A	0.5	23%	7.5%
B	1.0	38%	12.0%
C	2.0	45%	14.0%

An analyst has used market- and firm-specific information to generate expected return estimates for each stock. The analyst’s expected return estimates may or may not equal the stocks’ required returns. You’ve also determined that the risk-free rate [rRFrRF] is 4%, and the market risk premium [RPMRPM] is 5%.

Given this information, use the following graph of the security market line (SML) to plot each stock’s beta and expected return on the graph.

Tool tip: Mouse over the points in the graph to see their coordinates.

Stock AStock BStock C00.20.40.60.81.01.21.41.61.82.020181614121086420RATE OF RETURN (Percent)RISK (Beta)

A stock is in equilibrium if its required return equals its expected return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock’s prospects and may think that a stock is out of equilibrium (either undervalued or overvalued). Use the analyst’s expected return estimates to determine if this analyst thinks that each stock in Wilson’s portfolio is undervalued, overvalued, or fairly valued.

	Undervalued	Fairly Valued	Overvalued
Stock A
Stock B
Stock C

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE