Question

The expected return on the market portfolio is 13%. The risk-free rate is 6%. The expected return on SDA Corp. common stock is 12%. The beta of SDA Corp. common stock is 1.50. Within the context of the capital asset pricing model, _________.
A) SDA Stock is underpriced.
B) SDA stock is fairly priced.
C) SDA Corp. stock's alpha is –1.80%.
D) SDA stock's alpha is 1.8%.

Answer 1

Answer:

-4.50%

Explanation:

As we know that

Expected Rate of Return = Risk Free Rate of Return + Beta × Market Risk Premium

where,

Market Risk Premium is

= Expected Return on Market Portfolio - Risk Free Rate

= 13% - 6%

= 7%

So, the expected rate of return is

= 6% + 1.50 × 7%

= 16.50%

And the expected return on SDA Corp. common stock is 12%

So, the SDA Corp stock alpha is -4.50%

which come from

= 12% - 16.50%

This is the answer and the options that are mentioned are wrong.