Question

1. You are analyzing a common stock with a beta of 1.5. The risk-free rate of interest is 5 percent and the expected return on the market is 15 percent. If the stock's return based on its market price is 21.5%,

the stock is overvalued since the expected return is above the SML. the stock is undervalued since the expected return is above the SML. the stock is correctly valued since the expected return is above the SML. the stock is overvalued since the expected return is below the SML. the stock is undervalued since the expected return is below the SML.

2. Pepcico Inc. has a beta of 0.59. The risk-free rate is 2% and the market risk premium is 6%. What is the required rate of return of Pepcico? Round to the nearset hundredth percent. Answer in the percent format. Do not include % sign in your answer (i.e. If your answer is 4.33%, type 4.33 without a % sign at the end.)

3. You are analyzing a common stock with a beta of 2.8. The risk-free rate of interest is 5 percent and the expected return on the market is 12 percent. What is the stock's equilibrium required rate of return? Round to the nearest hundredth percent. Answer in the percent format. Do not include % sign in your answer (i.e. If your answer is 4.33%, type 4.33 without a % sign at the end.)

4. Which of the following is NOT an example of factors that affect systematic risk?

A change in tax rate Business cycle changes A company's labor force goes on strike An unexpected change in interest rates None of the above

Answer 1

1.return as per SML = Risk free rate + Beta*(Market return – Risk free rate)

= 5% + 1.5*(15%-5%)

= 20%

The actual return is 21.5%

• the stock is undervalued since the expected return is above the SML.

2.Required rate of return of Pepcico = Risk free rate + beta*market risk premium ‘

= 2% + 0.59*6%

= 5.54%

3.stock's equilibrium required rate of return = 5% + 2.8*(12%-5%)

= 24.6%

4.Systematic risk is the diversifiable risk which pertains to a specific company

Hence, the right answer is

• An unexpected change in interest rates