Question

Stock Y has a beta of 1.2 and an expected return of 12.1%. Stock Z had a beta of 0.8 and an expected return of 7.85%. The risk-free rate is 2.4% and the market risk premium is 7.2%. Are these stocks correctly priced

Answer 1

Answer:

Since the expected return and required return are different for both Stock X and Z, we say that they are not correctly priced

Explanation:

To determine whether or not the stocks are correctly priced ,

we have to compare the required return and the expected return on each of them.

Required return = Rf +β (Rm-Rf)

Note that Rm-Rf  is also known as market risk premium

                                  Stock Y                         Stock Z

Required return         2.4% + 1.2(7.2%)            2.4% + 0.8(7.2%)

                                  = 11%                                   = 8.2%

Expected return            12.1%                           7.85%

Since the expected return and required return are different for both Stock X and Z, we say that they are not correctly priced