Question

An analyst determines that four stocks have the following characteristics:

Stock     Beta       Estimated Return

A            0.6         5%

B             1.0         10%

C             1.6         16%

D            2.0         16%

If the risk-free rate is 4% and the expected return on the market is 10%, which of the following statements is FALSE?

Which stock is: Overvalued? Undervalued? Properly valued?

Answer 1

As per the details given in the question-
Rm -Rf = market risk premium
Rf = risk free rate
Rm = Market return
Required rate of return = Rf +(Rm-Rf)*beta
Calculaion of Required rate of Return -
Stock A -
Re = 4 + (5-4)*0.6
Re = 4.6%

Stock - B
Re = 4 + (10 - 4)*1
Re = 10%

Stock - C
Re = 4+ (16 - 4)*1.6
Re= 23.2%

Stock -D
Re = 4 + (16 - 4)*2
Re = 28%%

Stock B is Fairly Valued
Stock A is undervalued
Stock C & D are Overvlued

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