Answer:
Thus, both the stocks are not priced properly.
Stock A is priced less by 13.92 - 13.1 = 0.82%
Stock B is priced over by 11.4 - 11.247 = 0.153%
Explanation:
Using Capital Asset Pricing Model we have,
Expected return on stock = Rf + Beta(Rm - Rf)
Where Rf = Risk free rate of return
Rm = Expected return on market
Beta = Risk volatility of stock in relation to market
For Stock A
We have expected return = 13.1%
Actual expected return as computed = 4.2 + 1.2(12.3 - 4.2)
= 4.2 + 9.72 = 13.92%
For Stock B
We have expected return = 11.4%
Actual expected return as computed = 4.2 + 0.87 (12.3 - 4.2)
= 4.2 + 7.047 = 11.247%
Thus, both the stocks are not priced properly.
Stock A is priced less by 13.92 - 13.1 = 0.82%
Stock B is priced over by 11.4 - 11.247 = 0.153%
