Which of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent? More than one may be correct
Stock | Beta | Expected Return |
A | 0.87 | 11.03% |
B | 1.09 | 12.50% |
C | 1.18 | 13.21% |
D | 1.34 | 15.02% |
E | 1.62 | 17.07% |
Required return=risk free rate+beta*(market rate-risk free rate)
Required return for:
A=3.2+(11.76-3.2)*0.87=10.6472%
B=3.2+(11.76-3.2)*1.09=12.5304%
C=3.2+(11.76-3.2)*1.18=13.3008%
D=3.2+(11.76-3.2)*1.34=14.6704%
E=3.2+(11.76-3.2)*1.62=17.0672%(or 17.07% approx).
A stock is correctly priced if required return=expected return
Hence Stock E is correctly priced.
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