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A stock has n HPR of 8%. The stock's beta is 1.38. The risk-free rate is...

A stock has n HPR of 8%. The stock's beta is 1.38. The risk-free rate is 1% and the market risk premium is 6.23%.  Would you buy it or short it? If so, how much will you gain? Answer as a percent. Show work.

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Homework Answers

Answer #1

HPR = 8%

Using CAPM,

Required Return = Risk free rate + Beta * (Market Risk premium)

Required Return = 1 + 1.38 * (6.23) = 9.60%

Required return is the return needed for taking particular risk, where risk is measured using Beta.

If required return > HPR, stock is overvalued

Required Return < HPR, stock is undervalued.

As required return > HPR, stock is overvalued.

Since stock is overvalued, we will short it.

Gain = 9.60 - 8 = 1.6 Answer

Please let me know in case you have any queries and I will be happy to assist you.

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