Stock XYZ has an expected rate of return of 8% and risk of B= 0.40. Stock ABC has an expected return of 15% and B=1.30....
Stock XYZ has an expected rate of return of 8% and risk of B= 0.40. Stock ABC has an expected return of 15% and B=1.30. The markets return is 12% and the risk free rate is 4%
A) According to CAPM, Which stock is a better buy?
B) What is the alpha on each stock? Plot the SML and each and each stocks risk-return point on one graph. Label everything appropriately and show the alphas graphically
Homework Answers
Required Rate of XYZ = 0.04 + 0.40(0.12 - 0.04)
Required Rate of XYZ = 7.20%
Required Rate of ABC = 0.04 + 1.30(0.12 - 0.04)
Required Rate of ABC =14.40%
Stock XYZ is more undervalued so it should be bought.
Alpha of Stock XYZ = 0.08 - 0072 = 0.80%
Alpha of Stock ABC = 0.15 - 0.144 = 0.60%
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