Question 29 Which one of the following stocks is correctly p

Question 29 Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent? Stock Beta Expected Return A 0.87 B 1.09 ? 1.18 D 1.34 E 1.62 O E 11.03% 12.50% 13.21% 15.02% 17.07% ?? O B O D

Solution

required return= risk-free rate +Beta*(MArket rate- risk-free rate )

=3.2+Beta*(11.76-3.2)

=3.2+Beta*8.56

Required return forStock

A: =3.2+0.87*8.56=10.6472%

B: =3.2+1.09*8.56=12.5304%

C: =3.2+1.18*8.56=13.3008%

D: =3.2+1.34*8.56=14.6704%

E: =3.2+1.62*8.56=17.0672%(or 17.07% approx).

A stock is correctly priced if required return=expected return

Hence E is correctly priced.