The market price of a stock is 40 dollars, the stock’s expected return is 13%, the riskless rate is 7%, and the market risk premium is 8%.
(a) List the minimal set of assumptions that lead to the CAPM restriction on asset prices.
(b) Under the CAPM, what is the stock risk measured by? And how much is this measure currently?
(c) By how much will the stock’s trading price move if its expected future payoff remains the same, but the covariance of its rate of return with the market portfolio doubles? Explain.