Question

If a given investor believes that a stock’s expected return exceeds its required return, then the investor most likely believes that

		a. the stock is a good buy.
		b. dividends are not likely to be declared.
		c. the stock is experiencing supernormal growth.
		d. management is probably not trying to maximize the price per share.
		e. the stock should be sold.

Answer 1

The correct answer is a. the stock is a good buy.

• Expected Return is the actual return earned by the stock.
• · Required rate of return is the return an investor expects to earn from a stock.
• For the view point of an investor he would always want the actual return to be greater than his expected return (Re).
• In a situation where the expected return exceeds the required rate of return then the stock is a good buy as it would be providing us with more return than what we expect. Thus investor should go long (buy) on the stock and enjoy the additional return from it.