Question

Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security isA. underpriced. B. overpriced.C. fairly priced.D. Cannot be determined from data provided.

Answer 1

Answer:

C. Fairly priced

Explanation: use the equation of calculating Capital Asset Pricing Model CAPM

ER=Rf+βi(ERm−Rf)

where:

ER =expected return of investment = ?

Rf=risk-free rate = 4%

βi=beta of the investment = 1.1

(ERm−Rf)=market risk premium = (10% - 4%)

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Therefore ER=Rf+βi(ERm−Rf)

= 4% + 1.1(10% - 4%)

=10.6%

therefore, the security is fairly priced