QUESTION 5 =(040×0.12)+(0.25×0.1)+(035×0.15) 0.048+0.0275+0.0525 =0.128or12.8% =(040×100)+(025×075)+(035×130) 0.40+0.1875+0455 (b) Shares 1 and 2 seem to be right in line with the secur ity market line, which suggests that they are earning a fair return, given their systematic risk. Share 3, on the other hand, is earning more than a fair return(above the security market line). We might be tempted to conclude that security 3 is undervaluedJuly 2003 QUESTION 5 (a) ( ) ( ) ( ) 0.128 or 12.8% 0.048 0.0275 0.0525 0.40 0.12 0.25 0.11 0.35 0.15 k w k n j 1 p j j = = + + =  +  +  =  = ( ) ( ) ( ) 1.0425 0.40 0.1875 0.455 0.40 1.00 0.25 0.75 0.35 1.30 b w b n j 1 p j j = = + + =  +  +  =  = (b) Shares 1 and 2 seem to be right in line with the security market line, which suggests that they are earning a fair return, given their systematic risk. Share 3, on the other hand, is earning more than a fair return (above the security market line). We might be tempted to conclude that security 3 is undervalued