The risk-free rate is 3.5 percent and the expected return on the market is 11 pe
ID: 2636602 • Letter: T
Question
The risk-free rate is 3.5 percent and the expected return on the market is 11 percent. Stock A has a beta of 1.1 and an expected return of 12 percent. Stock B has a beta of 0.92 and an expected return of 10.25 percent. Are these stocks correctly priced? Why or why not?
No; Stock A is underpriced and stock B is overpriced.
No; Stock A is underpriced but stock B is correctly priced.
No; Stock A is overpriced and stock B is underpriced.
No; Stock A is overpriced but stock B is correctly priced.
Yes; Both stocks are correctly priced.
No; Stock A is underpriced and stock B is overpriced.
No; Stock A is underpriced but stock B is correctly priced.
No; Stock A is overpriced and stock B is underpriced.
No; Stock A is overpriced but stock B is correctly priced.
Yes; Both stocks are correctly priced.
Explanation / Answer
A =3.5*1.1*7.5 = 11.75
B = 3.5+.92*7.5 = 10.4
Stock A is overpriced as its return of 12% is more than the expected return based on market.
Stock B is underpriced as its return of 10.25% is less than expected return based on market
Answer is No,Stock A is overpriced and stock B is underpriced.
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