A stock is in equilibrium if its expected return its required return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either , Stock B is undervalued or overvalued). Based on the analyst's expected return estimates, Stock A is and Stock C is in equilibrium and fairly valued.
A stock is in equilibrium if its expected return its required return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either , Stock B is undervalued or overvalued). Based on the analyst's expected return estimates, Stock A is and Stock C is in equilibrium and fairly valued.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
10
Transcribed Image Text:Brian holds a portfolio that invests equally in three stocks, such that w₁ = B = wc = 1/3. Each stock is described in the following table:
Stock Beta Standard Deviation
A
0.5
B
1.0
с
2.0
23%
38%
45%
Expected Return
7.5%
12.0%
14.0%
An analyst has used market- and firm-specific information to make expected return estimates for each stock. The analyst's expected return estimates
may or may not equal the stocks' required returns.
The risk-free rate (TRP) is 4%, and the market risk premium (RPM) is 5%. Use the following graph of the security market line (SML) to plot each
stock's beta and expected return on the graph. Tool tip: Mouse over the points on the graph to see their coordinates.
Transcribed Image Text:The risk-free rate (TRP) is 4%, and the market risk premium (RPM) is 5%. Use the following graph of the security market line (SML) to plot each
stock's beta and expected return on the graph. Tool tip: Mouse over the points on the graph to see their coordinates.
Ⓒ
RATE OF RETURN (Percent)
16
14
12
10
8
4
2
4
0 +
0
0.2 0.4 0.6
0.8 1.0 1.2
RISK (Beta)
1.4
1.6 1.8
→
2.0
Stock A
Stock B
Stock C
A stock is in equilibrium if its expected return
its required return. In general, assume that markets and stocks are in equilibrium
(or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either
undervalued or overvalued). Based on the analyst's expected return estimates, Stock A is
Stock B is
Stock C is in equilibrium and fairly valued.
7
and
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