Question

The risk-free rate of return is currently 3.9 percent and the market portfolio return is estimated...

The risk-free rate of return is currently 3.9 percent and the market portfolio return is estimated to be 14.7 percent. The expected returns and betas of four shares are as follows: Share Beta Expected Return (%) A 1.47 19.78 B 1.40 18.72 C 0.90 13.62 D 1.61 21.29 According to CAPM which stocks are overvalued?
D and A
C and D
Only B
Only D
Only A

Homework Answers

Answer #1

SML Return or Required Ret = Rf + Beta ( Rm - Rf )

Rf = Risk Free Rate

Beta = Systematic Risk

Rm = Market ret

If SML Ret > Expected Ret - Over Valued - Reject

If SML = Expected Ret - Perfectly price - Accept/ Reject

If SML Ret < Expected Ret - Under Value - Accept

Share Rf Rm- Rf Beta ( Rm - Rf ) SML ret Expected Ret Over/ Under valued
A 3.90% 0.108 0.15876 19.78% 19.78% Perfectly Priced
B 3.90% 0.108 0.1512 19.02% 18.72% Over Valued
C 3.90% 0.108 0.0972 13.62% 13.62% Perfectly Priced
D 3.90% 0.108 0.17388 21.29% 21.29% Perfectly Priced

Only B is Over Valued.

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