STOCK UNDERVALUED
STOCK UNDERVALUED
Undervalued/Overvalued Stock dealing w/ beta?
The expected return on stock C is 10%, and it's beta is 1.5
The risk free rate is 2%.
The Expected Return on Market Portfolio is 8%.
According to CAPM; stock Cis ______ and it lies on _____the Security market line (SML)
a) Undervalued, Above
b) Overvalued, Below
c.) undervalued, On
d) overvalued, above
e.) undervalued, below
This is off a homework assignment... I can't figure it out....Can any one help me out??
Sure the answer requires you know the formula for CAPM.
Rf + B{Rm-Rf}
Therefore plugging in the numbers you have
.02 + 1.5(.08-.02) = .11
Since the stocks expected return is less than the required return per CAPM, the stock is Overvalued i.e. the discount rate (per the market) is too low and this stock would therefore plot below the SML.
If you need more explanation, feel free to ask and I can elaborate.
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