Suppose the Capital Asset Pricing Model (CAPM) is valid in a market. Use CAPM to ex- plain and answer following questions. Note: There is no relationship between each situation. (a) Can security A...

Extracted text: Suppose the Capital Asset Pricing Model (CAPM) is valid in a market. Use CAPM to ex- plain and answer following questions. Note: There is no relationship between each situation. (a) Can security A exist in the market? (Hint: Security market line) If yes, compute risk premium on security A. If not, is this security underpriced or overpriced? Expected return 5% Asset Beta Risk-free Market 12% 1 A 15% 1.3 (b) Can security B exist in the market? (Hint: Security market line) If yes, compute risk premium on security B. If not, is this security underpriced or overpriced? Expected return 6% Asset Beta Risk-free Market 13% 16.5% 1 1.5 Suppose the expected cash flow can be collected from investment in security B is $1000 at time 1. And an investor thinks the beta of security B is 1.8. But the actual beta is given in the above table. Then how much more/less (you also need to select "more" or "less") will he offer for the firm than it is truly worth at time 0? Hint: the present value of the cash flow = cash flow ErB under certain beta" (c) Can security C exist in the market? (Hint: Capital market line) If yes, compute risk premium on security C. Asset Risk-free Market Expected return 7% Standard deviation 15% 10% 12% 18%