Question

Which one of the following stocks is correctly priced if the risk-free rate of return is 2.7 percent and the market risk premium is 7.2 percent?

beginarray|c|c|c|
hline
textStock & textβ & textExpected Return
hline
texta & 0.71 & 7.90%
textb & 1.43 & 12.41%
textc & 1.24 & 11.16%
textd & 1.38 & 11.56%
texte & 0.95 & 9.54%
hline
endarray
a) Stock a
b) Stock b
c) Stock d
d) Stock e
e) Stock c

Answer 1

Stock b is the correctly priced stock based on its expected return.

Step-by-step explanation:

To determine the correctly priced stock, we need to calculate the expected return for each option. The expected return can be calculated using the formula:

Expected Return = Risk-Free Rate + (Beta x Market Risk Premium)

Using this formula, we find that the expected returns for each stock are as follows:

• Stock a - 7.9%
• Stock b - 12.41%
• Stock c - 11.16%
• Stock d - 11.56%
• Stock e - 9.54%

Therefore, Stock b is the correctly priced stock as it has the expected return closest to its beta multiplied by the market risk premium.