Question

Security X has an expected rate of return of 13% AND A BETA OF 1.15. The risk-free is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _______.

a. fairly priced

b. overpriced

c. underpriced

d none of these answers

(I need assistance on how to calculate and conclude.)

Answer 1

The beta of the stock is 1.15

Risk Free Rate = 5%

Market Expected Return = 15%

Required Rate of return of the stock (X) = Risk-Free Rate + Beta* (Market Return – Risk-Free rate)

Or, Required rate of return = 5% + 1.15* (15- 5) % = 16.5%

The required rate of return for the stock is 16.5% while the expected return for the stock (X) is 13% which states that the stock is overpriced and hence the returns will fall as the risk taken (measured by Beta will fall considering the expected price. So option (b) is correct.