Question

Consider the anticipated return information on Stock H and G below:

Stock	Dividend Yield	Capital Gains Yield	Beta
H	5.0%	10.0%	1.4
G	7.0%	7.0%	0.9

Risk-free rate (R_F) = 7%

Expected Return on the market (R_M ) = 14%

Based only on the above information, which of these stocks should be bought?

Group of answer choices

Both Stock H and G

Just Stock H

Neither Stock H nor G

Just Stock G

Answer 1

  

_______________________________

_______________________________

Expected Return = Dividend yield + Capital gain yield

H = 5% + 10% = 17%

G = 7% + 7% = 14%

Reqruired Rate as poer CAPM = Rf + beta * (Rm - Rf)

H = 7% + 1.4 * (14% - 7%)

= 16.8%

H = 7% + 0.90 * (14% - 7%)

= 13.3%

When Expected Return < CAPM, stock is overvalued and should not be bought but sold.

Both the stocks should be bougtht

Option 1 is correct.

NOTE: Do upvote the answer, if this was helpful.

NOTE: Please don't downvote directly. In case of query, I will solve it in comment section in no time.