Question

A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free rate is 5%. The asset is:

Select one:

a. under-priced

b. appropriately priced

c. overpriced

d. There is not enough information to answer the question

Answer #1

*Here, to say whether a stock is underpriced, fairly priced
or over priced, we have to look at the results that we will get by
CAPM model.*

Lets put the given value in CAPM (Capital Asset Pricing Model) to get the insights about the stock.

**CAPM Model : Expected stock returns = Risk-free rate
+ (Expected market returns - Risk-free return) * Beta of the
stock.**

*From the given question, we have following things.*

risk free rate = 5%,

Expected market returns = 13%

beta of the stock = 1.2

**therefore, Expected stock returns = 5% + (13% - 5%) *
1.2 = 14.6%**

**Now, in the question it is given that expected returns
on the stock was 10%, but from the CAPM calculations we have
calculated it as 14.6%.**

**The calculated CAPM value(14.6%) is greater than the
expected one(10%), which implies that the stock we are talking
about is overpriced.**

A particular asset has
a beta of 1.2 and an expected return of 10%. The expected return on
the market portfolio is 13% and the risk-free rate is 5%.
The share is:
--
Hint:
Compare Expected Return to Required Return
A. overpriced
B. underpriced
C. appropriately priced
D. There is not enough information to answer the question.
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