7: Risk, Return and the Capital Asset Pricing ModelP7-23 You believe that a particular share has an expected return of 15%. The share’s beta is 1.2, the risk-
free rate is 3%, and the expected market risk premium is 6%. Based on this, is it your view that the
share is overvalued or undervalued?
P7-24 A particular share sells for $30. The share’s beta is 1.25, the risk-free rate is 4%, and the expected
return on the market portfolio is 10%. If you forecast that the share will be worth $33 next year
(assume no dividends), should you buy the share or not?
P7-25 Currently, the risk-free rate equals 5% and the expected return on the market portfolio equals 11%.
An-investment analyst provides you with the following information:
Share Beta Expected return
A 1.33 12%
B 0.70 10%
C 1.50 14%
D 0.66 9%a Indicate whether each share is overpriced, underpriced or correctly priced.
b For each share, subtract the risk-free rate from the share’s expected return and divide the result
by the share’s beta. For example, for asset A this calculation is (12% – 5%) ÷ 1.33. Provide an
interpretation for these ratios. Which share has the highest ratio and which has the lowest?
c Show how a smart investor could construct a portfolio of shares C and D that would outperform
share A.
d Construct a portfolio consisting of some combination of the market portfolio and the risk-free
asset such that the portfolio’s expected return equals 9%. What is the beta of this portfolio?
What does this say about share D?
e Divide the risk premium on share C by the risk premium on share D. Next, divide the beta of
share C by the beta of share D. Comment on what you find.On your first day as an intern at Tri-Star Management Pty
Ltd, the CEO asks you to analyse the following information
pertaining to two ordinary share investments, Tech.com and
Sam’s Grocery. You are told that a one-year Treasury note
will have a rate of return of 5% over the next year. Also,
information from an investment advisory service lists the
current beta for Tech.com as 1.68 and for Sam’s Grocery as
0.52. You are provided a series of questions to guide your
analysis.Economy Probability Estimated rate of return
Tech.com Sam’s Grocery ASX 200
Recession 30% –20% 5% –4%
Average 20% 15% 6% 11%
Expansion 35% 30% 8% 17%
Boom 15% 50% 10% 27%mini case