11-7 We have the following information on Stocks A and B. The risk-free rate is 5%, and the market risk premium is 7.5%. Assume that the market portfolio is correctly priced. Based on the reward-to-risk ratio, are Stocks A and B overpriced, underpriced, or correctly priced? Stock A Stock B Expected return 11% 16.25% Beta 0.8 1.5 Select one: a. A is underpriced; B is overpriced. b. A is correctly priced; B is overpriced. c. A is overpriced; B is underpriced. d. A is correctly priced; B is underpriced e. Both stocks are correctly priced.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
11-7
We have the following information on Stocks A and B. The risk-free rate is 5%, and the market risk premium is 7.5%. Assume that the market portfolio is correctly priced. Based on the reward-to-risk ratio, are Stocks A and B overpriced, underpriced, or correctly priced?
|
|
Stock A |
Stock B |
|
Expected return |
11% |
16.25% |
|
Beta |
0.8 |
1.5 |
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
