1. Portfolio Risk and Return. According to the CAPM, would the expected rate of return on a security with a beta less than zero be more or less than the risk-free interest rate? Why would investors invest in such a security?
2. Risk and Return. Suppose that the risk premium on stocks and other securities did, in fact, rise with total risk (i.e., the variability of returns) rather than just market risk. Explain how investors could exploit the situation to create portfolios with high expected rates of return but low levels of risk.
3. CAPM and Valuation. You are considering acquiring a firm that you believe can generate expected cash flows of $10,000 a year forever. However, you recognize that those cash flows are uncertain. (LO12-2)a. Suppose you believe that the beta of the firm is .4. How much is the firm worth if the risk-free rate is 4% and the expected rate of return on the market portfolio is 11%?b. By how much will you overvalue the firm if its beta is actually