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Keith holds a portfolio that is invested equally in three stocks (Wd = Wa = Wi = 1/3). Each stock is described in the following table: Stock Beta Standard Deviation Expected Return DET 0.7 25% 8% AIL

Keith holds a portfolio that is invested equally in three stocks (Wd = Wa = Wi = 1/3). Each stock is described in the following table:

Stock Beta Standard Deviation Expected Return
DET 0.7 25% 8%
AIL 1.0 38% 10%
INO 1.6 34% 13.5%

An analyst has used market and firm-specific information to make expected return estimates for each stock. The analyst's expected return estimates may or may not equal the stocks' required returns.

The risk-free rate (Rf) is 6% and the market risk premium (Rp) is 4%. Use the following graph with the security market line (SML) to plot each stock's beta and expected return.

 

 

 

 

 

 

 

 

 

 

 

 

 

A stock is in equilibrium if its required return ___________ 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). Based on the analyst expected return estimates, stock INO is ___________, stock AIL is equilibrium, and stock DET is _________.

 

Apr 10 2021 View more View Less

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