Question

Suppose the required rate of return on a stock with Beta 1.2 is 18 per cent and risk free rate is 6 per cent. According to the CAPM

a) What is the expected rate of return on the market portfolio?

b) What is the expected rate of return of a zero-beta security?

c) Suppose you select Stock ABC for Rs. 50 and the stock is expected to pay a dividend of rs. 2 next year and is expected to fetch Rs. 53 when sold. The stock has a beta of -0.5. Is the stock fairly priced, overvalued or undervalued?

d) A stock XYZ has Beta 1.5 and one year from now is expected to yield dividend income of Rs. 6. What is the fair price stock XYZ if its growth rate is 10 per cent?

c) Suppose you select

Answer #1

Beta = 1.2

Rf = 6%

Rm = 18%

a) Re = Rf + B(Rm-Rf)

Re = 6 + 1.2(18-6)

Re = 20.4

**Expected rate of return = 20.4%**

b) When B = 0

Re = Rf + B(Rm-Rf)

Re = 6 + 0(18-6)

Re = 6

**Expected rate of return = 6%**

c) Actual Return on Stock = Capital gain on sale plus dividend

= (53-50)+2 = 5

Actual return on stock = (5/50*100) = 10%

Return as per CAPM

Re = Rf + B(Rm-Rf)

Re = 6 + -0.5(18-6)

Re = 0

Since the Actual return is greater than the expected return as
per CAPM, the security is **undervalued.**

d) Re as per CAPM = 6 + 1.5(18-6) = 24%

Re = Dividend/Price + Growth Rate

0.24 = 6/Prirce + 0.1

0.14 = 6/Price

Price = 6/0.14

**Fair Price of Share = 42.86**

Stock Y has a beta of 1.2 and an expected return of 15.3 percent.
Stock Z has a beta of .8 and an expected return of 10.7 percent. If
the risk-free rate is 6 percent and the market risk premium is 7
percent, the reward-to-risk ratios for stocks Y and Z
are and percent, respectively. Since the SML
reward-to-risk is percent, Stock Y is Undervalued of
Overvalued (pick one) and Stock Z is Undervalued of
Overvalued (pick one). (Do not round intermediate
calculations. Enter...

Home Interior's stock has an expected return of 13.2 percent and
a beta of 1.28. The market return is 10.7 percent and the risk-free
rate is 2.8 percent. This stock is overvalued or undervalued?
____________ because the CAPM return for the stock is ________
percent. If Home Interior's expected return rose to 14.12%, the
stock would be overvalued or undervalued? ____________ because the
CAPM return for the stock is ________ percent. Please show your
work.

Stock Y has a beta of 1.5 and an expected return of 14.2
percent. Stock Z has a beta of 0.85 and an expected return of 10.7
percent.
Required:
If the risk-free rate is 4.6 percent and the market risk premium
is 7.1 percent, are these stocks correctly priced?
Stock Y
undervalued or overvalued?
Stock Z
undervalued or overvalued?

A stock with a beta of 0.77 currently priced at $45 is expected
to increase in price to $65 by year-end and pay a $1 dividend. The
expected market return is 17%, and the risk-free rate is 8%.
Determine by calculations if the stock is overvalued or
undervalued.

a. Suggest an example of an asset with zero beta. Explain
whether an asset with zero beta offers an expected return of zero.
b. Milton considers buying the ABC stock. The ABC stock pays a
constant dividend of $5 in perpetuity, and the beta of the ABC
stock is 1.2. The risk-free rate is 4%, and the expected market
return is 12%.
i. Compute the price of the ABC stock based on the CAPM.
ii. Suppose the market price of...

a. Suggest an example of an asset with zero beta. Explain
whether an asset with zero beta offers an expected return of zero.
b. Milton considers buying the ABC stock. The ABC stock pays a
constant dividend of $5 in perpetuity, and the beta of the ABC
stock is 1.2. The risk-free rate is 4%, and the expected market
return is 12%.
i. Compute the price of the ABC stock based on the CAPM.
ii. Suppose the market price of...

a. Suggest an example of an asset with zero beta. Explain
whether an asset with zero beta offers an expected return of zero.
b. Milton considers buying the ABC stock. The ABC stock
pays a constant dividend of $5 in perpetuity, and the beta of the
ABC stock is 1.2. The risk-free rate is 4%, and the expected market
return is 12%. i. Compute the price of the ABC stock based on the
CAPM. ii. Suppose the market price of...

Suppose stock of Company ABC has a beta of 1.2. The risk premium
is 8%, and the risk-free rate is 6%. ABC’s last dividend was $2 per
share, and the dividend is expected to grow at 8% indefinitely. The
stock sells for $30. What is ABC’s cost of equity capital?

If security X’s beta is 1.30, the expected return on the market
is 6%, and the risk-free rate is 1%.
What must the expected return on this stock be? (10
points)
b.If the current expected return of security X is 8%, is the
stock price fair, undervalued or overvalued? (10 points)

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