You estimate that Ulmer Inc. stock has a beta of 0.86 and an annual expected ret

Question

You estimate that Ulmer Inc. stock has a beta of 0.86 and an annual expected return of 10.5 percent. The annual risk-free rate of return is 3.2 percent and the annual market rate of return is 11.2 percent. Which one of the following statements is true? (2) (show support)

a. The expected return on Ulmer stock will plot below the Security Market Line (SML).

b. Ulmer stock is underpriced.

c. The expected return on Ulmer stock based on the Capital Asset Pricing Model (CAPM) is 12.83 percent.

d. Ulmer stock gives more exposure to systematic sources of risk than the overall market.

e. Ulmer stock is overpriced.

Explanation / Answer

Expected return of ulmer stock = Rf+beta(Rm-Rf) = 3.2+0.86(11.2-3.2) = 10.08

the estimate of annual expected return (10.5%) is greater than the expected return from CAPM (10.08%). thus Ulmer stock is overpriced

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