Tutorial 1.2 Memo
1. This statement is true.
The security market line (SML) is the graphical representation of CAPM. It displays the relationship
between the systematic risk (beta) and the expected return of a financial asset. In this graph, beta
and the expected return are displayed on the x-axis and the y-axis respectively. The slope of SML
stands for the market risk premium. Hence, when the slope of SML is positive, an increase in beta
results in the increase in expected rate of return.
2. Stock A has a beta of 1.2 and Stock B has a beta of 0.6. Which of the following statements is
true?
Answer: C
3. Consider a stock with a beta of 1.5. Which of the following statements is true?
Answer: D
4. Which of the following statements is true about the market risk premium?
Answer: A
5. Answer: C
6. Answer: A
7. Re = Rf + β(Rm-Rf)
Re = 3 + 2(8-3)
Re = 13%
8. Re = Rf + β(Rm-Rf)
14 = Rf + 1.5(10-Rf)
14 = Rf + 15 – 1.5Rf
14 = 15 – 0.5Rf
-1 = -0.5Rf
Rf = 2
9. Re = Rf + β(Rm-Rf)
Re = 6 + 0.66(12-6)
Re = 9.96%
10. Required rate of return = 4.75 + 0.95(11.25 – 4.75)
= 4.75 + 6.175
=10.925%
HPR = 23/20 – 1 × 100
= (1.15 – 1) – 100
Estimated rate of return (HPR) = 15%
Required rate of return < Estimated rate of return.
10.925% < 15%.
Therefore, the share is undervalued
Yes, you will purchase the share because it is undervalued