You are considering five stocks as additions to your portfolio. You want to understand if they...
You are considering five stocks as additions to your portfolio. You want to understand if they are priced correctly. With the following betas and expected returns, and knowing the market risk premium is 8.8% and the risk-free rate is 3.7%, only one is correctly priced. Which one is it?
| Stock | Beta | Expected Return |
| V | 0.64 | 9.47% |
| W | 0.97 | 12.03% |
| X | 1.22 | 14.44% |
| Y | 1.37 | 15.80 |
| Z | 1.68 | 18.37% |
Homework Answers
stock X.
Stock x is correctly priced.
required rate = risk free rate + beta*(market premium)
=>3.7% +1.22*(8.8)
=>14.436%
=>14.44%.
Since CAPM return and expected return are equal, stock X is correctly priced.
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