Question

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _________.

Answer 1

Answer:

Security X is __________.

Overpriced

Explanation:

The formula used in Capital Asset Pricing model to calculate the expected rate of return is as follow:

Expected Rate of Return = Risk Free Rate + beta (Market Expected Rate of return - Risk Free Rate)

Putting the values as given in above formula:

Expected Rate of Return = 5% + 1.15 ( 15% - 5%)

Expected Rate of Return = 5% + 11.5 %

Expected Rate of Return = 16.5 %

Normally, the expected Rate of return should be 16.5 % but it is 13% so security X is overpriced.