You Use the Single-Factor Model $R _ { i t } = \alpha _ { i } + \beta _ { i } R _ { m t } + e _ { i t }$

question 42

Essay

You use the single-factor model $R _ { i t } = \alpha _ { i } + \beta _ { i } R _ { m t } + e _ { i t }$
and have obtained the following estimates for stock A and stock B:
$\begin{array} { l l l l } \text { Stock } & \alpha & \beta & \sigma _ { e } \\\text { A } & 2 \% & 1.3 & 30 \% \\\text { B } & 10 \% & 1.2 & 40 \%\end{array}$
You also estimate that the expected return on the market portfolio is 16%,the standard deviation of the market portfolio is 20%,and the riskless rate is 8%.
a. Based on the single-factor model, what are the expected returns and standard deviations of stock A and stock B?
b. Based on the single-factor model, the Security Market Line, and the Capital Market Line, state whether each of the following statements is completely true, completely false, or uncertain. Explain your answers.
1) In any given year, stock B is certain to outperform stock A.
2) An investor would consider stock B to be riskier than stock A.
3) Stock A is undervalued.
4) If an investor had to select one investment to combine with the riskless asset, the investor would prefer stock A to the market portfolio.

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Definitions:

Relationships

The way in which two or more concepts, objects, or people are connected, or the state of being connected.

Sense Of Self

The way an individual perceives, views, and feels about themselves; a person's self-identity.

Emerging Adulthood

A phase of life transition between adolescence and full-fledged adulthood, characterized by exploration and self-discovery.

Erikson

Refers to Erik Erikson, a psychologist known for his theory on the psychosocial development of individuals across the lifespan.