According to the equation for the return on the stock

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According to the equation for the return on the stock, the actually expected return on the stock is 15% (because the expected surprises on all factors are zero by definition). Because the actually expected return based on risk is less than the equilibrium return, we conclude that the stock is overpriced. 13. b. Since Portfolio X has β = 1.0, then X is the market portfolio and E(R M ) =16%. Using E(R M ) = 16% and r f = 8%, the expected return for portfolio Y is not consistent. 14. d.
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10-5 15. c. 16. d. 17. c. Investors will take on as large a position as possible only if the mispricing opportunity is an arbitrage. Otherwise, considerations of risk and diversification will limit the position they attempt to take in the mispriced security. 18. d. 19. d. 20. The first two factors seem promising with respect to the likely impact on the firm’s cost of capital. Both are macro factors that would elicit hedging demands across broad sectors of investors. The third factor, while important to Pork Products, is a poor choice for a multifactor SML because the price of hogs is of minor importance to most investors and is therefore highly unlikely to be a priced risk factor. Better choices would focus on variables that investors in aggregate might find more important to their welfare. Examples include: inflation uncertainty, short-term interest-rate risk, energy price risk, or exchange rate risk. The important point here is that, in specifying a multifactor SML, we not confuse risk factors that are important to a particular investor with factors that are important to investors in general; only the latter are likely to command a risk premium in the capital markets.
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