Question

Stock a has a beta of 0.69 and an expected return of 9.27 %. Stock B has a 1.13 beta and an expected return of 11.88 %.Stock C has a 1.48 beta and an expected return of 14.26%. Stock D has a beta of .81 and an expected return of 8.71%. Stock E has a 1.45 beta and an expected return of 15.04%. Which of these stocks is correctly priced if the risk free rate of return is 15.36 % and the market rate of return is 10.8%?

Answer 1

As per CAPM,

Rf = Risk free Return = 15.36%

Rm = Market return = 10.8%

a). Beta of Stock A = 0.69

Required Return of Stock A = 15.36% + 0.69(10.8% - 15.36%)

= 12.2136%

Expected return = 9.27%

Thus, Stock A is overpriced.

b). Beta of Stock B = 1.13

Required Return of Stock A = 15.36% +1.13(10.8% - 15.36%)

= 10.2072%

Expected return = 11.88%

Thus, Stock B is underpriced.

c). Beta of Stock C = 1.48

Required Return of Stock A = 15.36% + 1.48(10.8% - 15.36%)

= 8.6112%

Expected return = 14.26%

Thus, Stock C is Underpriced.

d). Beta of Stock D = 0.81

Required Return of Stock A = 15.36% + 0.81(10.8% - 15.36%)

= 11.6664%

Expected return = 8.71%

Thus, Stock D is Overpriced.

e). Beta of Stock A = 1.45

Required Return of Stock A = 15.36% + 1.45(10.8% - 15.36%)

= 8.748%

Expected return = 15.04%

Thus, Stock E is Underpriced.

Hence, None of the Stock is correctly priced, as some are Overpriced and some are Underpriced.