Question

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% an model, security X is

A) fairly priced
B) overpriced
C) underpriced
D) None of the above answers are correct

Answer 1

Answer:

B) overpriced

Explanation:

The computation is shown below for expected rate of return by using the Capital Asset Pricing Model formula is

Required rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 5% + 1.15 × (15% - 5%)

= 5% + 1.15 × 10%

= 5% + 11.5%

= 16.50%

And, the expected rate of return is 13%

Since as we can see that the expected rate of return is less than the required rate of return so in this case the stock is overpriced