Question

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

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.