Question

Consider the following three equally likely scenarios for the economy and the returns in each scenario for a stock. Scenario Stock A Bust 7% Normal 9% Boom 11% If the T-bill rate is 4 percent and the rate of return on the market portfolio is 11 percent, what does CAPM say about the required rate of return on the stock? Assume that the beta of stock A is 1.5. Is this stock a good buy? The expected return is 9 percent; the required return is 14.5 %; therefore, it is a bad buy The expected return is 9 percent; the required return is 20.5 %; therefore, it is a good buy O The expected return is 9 percent; the required return is 14.5 %; therefore, it is a good buy O The expected return is 7 percent; the required return is 20.5 %; therefore, it is a bad buy

Answer 1

As pwe CAPM =

= R: + betal Rn - Ri)

= 4% + 1.5(11% - 4%)

= 14.5%

Expected Return in Normal scnerio 9% the required return 14.5%. there fore it is a bad buy because required rate of return is 14.5% while we are only expecting 9%. which is a bad buy

Option A is correct.

NOTE: The answer to your question has been given below/above. If there is any query regarding the answer, please ask in the comment section. If you find the answer helpful, do upvote. Help us help you