Answer:
Explanation:
<em>a.)</em> Return of stock;
CAPM; r = risk-free +Beta(Market return - risk-free )
risk free rate = 8% or 0.08 as a decimal
Beta = 0.6
Market return = 14% or 0.14
CAPM; r = 0.08 +0.6(0.14 - 0.08)
return ;r = 0.116 or 11.6%
<em>b.)</em> If return (r) is 20%;
CAPM; r = risk-free +Beta(Market return - risk-free )
return( r ) = 20% or 0.20 as a decimal
risk free rate = 8% or 0.08 as a decimal
Market return = 14% or 0.14
Beta = ?
0.20 = 0.08 +Beta(0.14 - 0.08)
0.20 - 0.08 = 0.06Beta
0.12 = 0.06Beta
Divide both sides by 0.06
0.12/0.06 = Beta
Beta = 2
c.) If a stock has a beta of 1.3 and a current return of 17%, what can you say about the stock’s current price?
Using CAPM, the return should be;
CAPM; r = risk-free +Beta(Market return - risk-free )
r = 0.08 +1.3(0.14 - 0.08)
r = 0.158 or 15.8%
Since the current return of 17%, is lower than the CAPM return of 15.8%, it means that the current stock price is undervalued
Direction? The stock is expected to go up eventually since there will be a higher demand in the market due to the lower price than the actual intrinsic value.
