Question

American Airlines, Acme Dynamite Company and Best Buy have the following betas respectively: 0.96, 1.72, 1.16. Calculate their expected return using the CAPM if the Treasury Bill rate is 2.5% and the market risk premium is 8%.

     If the actual returns are as follows:

         American – 11%, Acme – 15.2%, Best Buy – 9.3%, are these stocks over-priced, under-priced or correctly-priced?

Answer 1

As per CAPM, expected return = Risk free rate + Beta x market risk premium

Therefore expected returns of American Airlines = 2.5% + 0.96 x 8% = 10.18%

Expected returns of Acme Dynamite Company = 2.5% + 1.72 x 8% = 16.26%

Expected returns of Best Buy = 2.5% + 1.16 x 8% = 11.78%

	Actual return	Expected return	Pricing
American Airlines	11.000%	10.18%	Under Priced
Acme Dynamite Company	15.200%	16.26%	Over Priced
Best Buy	9.300%	11.78%	Over Priced