You are examining three different shares. Share A has expected return 6.20%, beta 0.47, and volatility 12.00%. Share B has expected return 4.90%, beta 0.19, and volatility 20.00%. Finally, share C has expected return 9.60%, beta 0.84, and volatility 30.00%. The risk free rate is 2.90%, while the market price of risk is 8.50%. According to the CAPM, which share is undervalued?
You are examining three different shares. Share A has expected return 6.20%, beta 0.47, and volatility 12.00%. Share B has expected return 4.90%, beta 0.19, and volatility 20.00%. Finally, share C has expected return 9.60%, beta 0.84, and volatility 30.00%. The risk free rate is 2.90%, while the market price of risk is 8.50%. According to the CAPM, which share is undervalued?
CAPM or Capital Asset pricing model is used to calculate the required rate of return to determine the value of the asset. It also determines whether the security is overvalued, undervalued or fairly valued.
Formula of CAPM is
Rf + (Rm -Rf) = Re
where Rf is risk free rate of return, Rm -Rf is market risk premium , is Beta of the security and Re is required rate of return.
If the required rate of return is more than the expected return, the security is said to be overvalued.
If the required rate of return is less than the expected return, the security is said to be undervalued.
If the required rate of return is equal to the expected return, the security is said to be fairly valued.
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