Question
The risk-free rate is 5 percent and the expected return on the market is 11 percent. Stock A has a beta of 1.2 and an
The risk-free rate is 5 percent and the expected return on the market is 11 percent. Stock A has a beta of 1.2 and an expected return of 13 percent. Stock B has a beta of .86 and an expected return of 10 percent. Are these stocks correctly priced and why? answer: a
a. No; Stock A is underpriced and stock B is overpriced.
b. No; Stock A is overpriced and stock B is underpriced.
c. No; Stock A is overpriced but stock B is correctly priced.
d. No; Stock A is underpriced but stock B is correctly priced.
e. Yes; Both stocks are correctly priced.
I know that E(Ra) = 5% + 1.2(11%-5%) = 12.2%
and E(Rb) = 5% + 0.86(11%-6%) = 10.16%
Compared with expected return 13% and 10% --> I thought that A is overpriced & B is underpriced.
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