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3. The risk-free rate is 3.7 percent and the expected return on the market is 12.3 percent. Stock A has a beta of 1.1 and an expected return of 13.1 percent. Stock B has a beta of .86 and an expected return of 11.4 percent. Are these stocks correctly priced

Respuesta :

Answer:

Stock A is not appropriately priced as the expected return of 13.1%is less than the one calculated at 13.2%

Stock B is not appropriately priced as the expected return of 11.4%is less than the one calculated at 11.10%

Explanation:

The expected return on stock can be computed as follows:

Ke=Rf+beta*(Market return-Rf)

Rf is the risk free rate of 3.7%

beta is 1.1

expected return is 13.1% as calculated

expected return is then calculated using the formula above

Ke=3.7%+1.1*(12.3%-3.7%)

Ke=13.16%  approx. 13.2%

For stock B:

Beta is 0.86

expected return is 11.4%

Ke=3.7%+0.86(12.3%-3.7%)

Ke=11.10%

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