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Which one of the following stocks is correctly priced if the risk-free rate of return is 2.8 percent and the market risk premium is 7.3 percent? Stock Beta Expected Return A .73 7.73 % B 1.44 12.43 C 1.25 12.50 D 1.40 11.59 E .80 8.64

Respuesta :

Shahzaibfaraz

Answer:

Stock E is correctly priced.

Explanation:

The stock's are fairly priced based on the required rate of return. If a stock's required rate of return is equal to its expected rate of return, the stock is fairly priced. The required rate of return can be calculated using the CAPM approach. The formula for required rate of return under CAPM is,

r = rRF + Beta * rpM

Where,

  • rRF is the risk free rate
  • Beta is the stock's beta
  • rpM is the market risk premium

Required rate of return of each stock

rA = 0.028 + 0.73 * 0.073 = 0.08129 or 8.129%

rB = 0.028 + 0.1.44 * 0.073 = 0.13312 or 13.312%

rC = 0.028 + 1.25 * 0.073 = 0.11925 or 11.925%

rD = 0.028 + 1.4 * 0.073 = 0.1302 or 13.02%

rE = 0.028 + 0.8 * 0.073 = 0.0864 or 8.64%

Comparing with the expected rate of return, we see that only Stock E's expected rate of return (8.64%) is equal to its required rate of return 8.64%. So, Stock E is correctly price.

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