Question

The expected return on the market is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual expected return of 12 percent. Is this stock overpriced or underpriced? What is it’s alpha?

Answer 1

Lexant stock is underpriced and has an alpha of 9%.

Step-by-step explanation:

To determine if Lexant stock is overpriced or underpriced, we need to compare its expected return to its actual expected return. The expected return of the market is 11 percent, and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market. If the stock has an actual expected return of 12 percent, it means that it has outperformed the market's expected return by 1 percent (12% - 11%). This indicates that the stock is underpriced because it is providing a higher return than expected for its level of risk.

The alpha of the stock is the excess return above the risk-free rate. In this case, the risk-free rate is 3 percent, and the stock's actual expected return is 12 percent. Therefore, the alpha can be calculated as 12% - 3% = 9%. This means that the stock has an alpha of 9%, indicating that it has the potential to outperform the risk-free rate by 9%.