If rate of return of risk-free asset = 5%, the expected rate of return required by the market for a portfolio with a beta of
1 is 12%. According to the capital asset pricing model (security market line):
a. What is the expected rate of return on the market portfolio?
b. What would be the expected rate of return on a stock with b=0 ?
c. Suppose you consider buying a share of stock at $40. The stock is expected to pay $3 dividends next year and you expect it to sell then for $41. The stock risk has been evaluated at b= -.5. Is the
stock overpriced or underpriced?
Acc. to my calculations this is d likely answer:
Acc. to CAPM model,
Ke = Rf + Beta (Rm – Rf)
= 0.05 + 1(.12-.05)
= .12
If Beta = 0,
Ke = 5%
c. Rm = 5%
Return from stock is 10%
hence the stock is underpriced.
Acc. to my calculations this is d likely answer:
Acc. to CAPM model,
Ke = Rf + Beta (Rm – Rf)
= 0.05 + 1(.12-.05)
= .12
If Beta = 0,
Ke = 5%
c. Rm = 5%
Return from stock is 10%
hence the stock is underpriced.
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