An analyst expects a risk-free return of 4.5 percent, a market return of 14.5 percent, and the returns for Stocks A and B that are shown in the following table.
Stock Beta Analyst’s Estimated Return
A 1.2 16%
B 0.8 14%
a. Show on the graph
(1) Where Stock A and B would plot on the security market line (SML) if they were fairly valued using the capital asset pricing model (CAPM)
(2) Where Stock A and B actually plot on the same graph according to the returns estimated by the analyst and shown in the table
b. State whether Stock A and B are undervalued or overvalued if the analyst uses the SML for strategic investment decisions.