A stock has an expected return of 14% based on its performance. Under the APT, given its risk exposure, the fair expected return is 18%. What would an arbitrageur trade in this situation? a. Buy the stock as price is too low. Buying increases price, reducing return. b. Buy the stock as price is too low. Buying increases price, increasing return. c. Do nothing - without risk free rate cannot tell. d. Short the stock as the price is too high. Selling reduces price, increasing return
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.
A stock has an expected return of 14% based on its performance. Under the APT, given its risk exposure, the fair expected return is 18%. What would an arbitrageur trade in this situation?
a.
Buy the stock as price is too low. Buying increases price, reducing return.
b.
Buy the stock as price is too low. Buying increases price, increasing return.
c.
Do nothing - without risk free rate cannot tell.
d.
Short the stock as the price is too high. Selling reduces price, increasing return
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