Question

Suppose the beta of Amazon is 2.2. the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. If the expected return is 12%, then Amazon is

a. Underpriced
b. Correctly priced
c. Cannot be determined
d. Overpriced Next
e. Do not copy from otherwise I have to report

Answer 1

According to the CAPM, Amazon, with a beta of 2.2, has an expected return of 23.1%, which is higher than the actual rate of return of 12%, indicating that the stock is overpriced.

Step-by-step explanation:

To determine if Amazon is underpriced or overpriced, we can use the Capital Asset Pricing Model (CAPM), which calculates expected return as follows:

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

Using the provided numbers, the calculation would be:
Expected Return = 5.5% + (2.2 × 8%)
Expected Return = 5.5% + 17.6%
Expected Return = 23.1%

Since the expected return of 23.1% is higher than the given actual rate of return of 12%, we can conclude that Amazon is overpriced because the return an investor would anticipate based on the risk (as measured by beta) is not being met.