Question

Question 3

Consider the following two investors’ portfolios consisting of investments in four stocks:

Stock Beta Jack's Portfolio Nelson's Portfolio A 1.3 $2,500 $10,000 B 1.0 $2,500 $5,000 C 0.8 $2,500 $5,000 D -0.5 $2,500 $2,500 Portfolio Expected Return 10% 9%


(a)

Calculate the beta on portfolios of Jack and Nelson respectively.

(b) Assuming that the risk-free rate is 4% and the expected return on the market is 12%, determine the required return on portfolios of Jack and Nelson respectively.

(c) From your answers in part (b), explain whether portfolios of Jack and Nelson are over-priced, under-priced or correctly priced.


(d) State and explain whether the following statement is true or false: “If a security lies above the security market line (SML), then it must be over-priced.” (word limit: 150 words)

Answer 1