Equity S has a beta of 1.2 and an actual return of 9.5 per cent. Equity T has a beta of 0.80 and an actual return of 12 per cent. The risk-free rate is 3 per cent and the market risk premium is 7 per cent.
i) Calculate the expected rate of returns of Equity S and T. State whether they are correctly priced? Explain why?
ii) Where do they lie in relation to the security market line (SML), and are they overvalued or undervalued? If they are overvalued or undervalued what should happen to their prices, in order for their returns to lie in the SML?