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In a hypothetical market r(j) Beta(j) Asset 1

In a hypothetical market

                                                                                                   r(j)                       Beta(j)

Asset 1                                                                                       6%                       0.75

Asset 2                                                                                      12%                      1.8

where r(j)= expected return of asset j; beta(j)=beta coefficient of asset j.

a. Based on the information from the table above, derive the Security Market Line (SML

b. Illustrate the SML in the space provided below. Label the axis.

c. Suppose that there is a third asset. Beta(3)= 2. Yahoo Finance reports that the average rate of return is 9%. What is the predicted return according to CAPM?

d. Is the asset overpriced or underpriced?

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