Question

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?
A. The actual expected stock return will graph above the security market line.
B. The stock is currently underpriced.
C. To be correctly priced according to CAPM, the stock should have an expected return of 13.56 percent.
D. The stock has less systematic risk than the overall market.
E. The actual expected stock return indicates the stock is currently overpriced.

Answer 1

Answer:

B

Explanation:

Using the capital asset pricing model, the expected return of the stock can be determined using this formula :

: Expected rate of return = risk free + beta x (market rate of return - risk free rate of return)

3.7% + 1.24 x (11.78 - 3.7) = 13.72%

the return calculated with the capm is higher than the expected return. Thus the stock is under-priced

Systemic risk is measured by beta. The higher beta is, the higher the systemic risk and the higher the compensation demanded for by investors

the market beta is 1. the stock is more risky than the overall market