Stock A will have a return of 18%, stock B will have a return of20 % and stock C

Question

Stock A will have a return of 18%, stock B will have a return of20 % and stock C will have a return of 22%, but his findings do notinvolve the CAPM (Capital Asset Pricing Model).

You are a business graduate and when you have used CAPM, you havecome to know that:

Stock A’s expected return is 15.50%, Stock B’sexpected return is 24.63% and Stock C’s expected return is25.39%.

In your opinion, whether the KSE has over-priced or under-pricedeach stock and in the light of these results, which of these stocksare suitable for investment?

Explanation / Answer

There is not enough information to decide which stocks to buy. Youneed to know each stock's current selling price to determine if theExpected Rate of Returns are adequate. "An asset is correctly priced when its estimated price is the sameas the required rates of return calculated using the CAPM. If theestimate price is higher than the CAPM valuation, then the asset isundervalued (and overvalued when the estimated price is below theCAPM valuation)."

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