CAPM and the security market line

CAPM and the security market line

1. 1. A stock has β = 1.4. Risk-free rate is 4.2%. Market risk premium is 6%. What is the CAPM expected return? Answer as a percent to one decimal.

   %

2. 2. A stock plots above the SML. The most direct interpretation is:

   The stock has positive alpha — it has outperformed what CAPM predictsThe stock has negative alphaBeta is zeroThe market is broken

3. 3. Cov(R_i, R_m) = 0.024, Var(R_m) = 0.020. What is β_i?

   0.831.01.21.5

4. 4. Why is a utility company's typical beta lower than a technology company's?

   Utilities are smaller firmsUtility revenues and earnings are less sensitive to economic cycles than tech revenues and earnings — so utility returns covary less with the marketUtilities pay higher dividendsRegulators require it