Question

Given a risk-free rate of return of 3.7 percent and a market risk premium of 8.8 percent, one of these stocks has an expected return that matches the market’s required rate of return. For the other stock, the expected return does not equal the market’s required rate of return. Expected Stock Beta Return A 0.65 6.80 B 1.22 14.44% For the incorrectly priced stock, according to the SML/CAPM at what rate of return would that stock’s price then be in equilibrium with the market?

Answer 1

Answer:

9.42%

Explanation:

According to the CAPM,

market required rate of return = risk free rate + (beta x market risk premium)

for stock A :

3.7% + (0.65 X 8.8%) = 9.42%

The market required rate of return isn't equal to the expected return based on the calculation.

for stock B :

3.7% + (1.22 X 8.8%) = 14.44%

for stock B, they both match