Question

When reviewing the investment policy statement annually, which investment would indicate that it is undervalued:

Group of answer choices
A value oriented mutual fund with stocks that have higher PE ratios than its peer group
An investment that falls below the security market line (SML)
An investment with a PEG ratio lower than its peer group
A real estate investment with a lower cap rate than comparable real estate assets

Answer 1

An investment that falls below the security market line (SML) would indicate that it is undervalued.

Step-by-step explanation:

When reviewing the investment policy statement annually, an investment that falls below the security market line (SML) would indicate that it is undervalued. The security market line (SML) is a graphical representation of the relationship between risk and return for individual securities.

Thus, It typically shows the expected return of a security based on its beta, which measures its systematic risk. If an investment falls below the SML, it means that it is providing a higher return for its level of risk, making it undervalued. For example, if a stock has a beta of 1 and is expected to provide a return of 10%, but falls below the SML and is actually providing a return of 15%, it would be considered undervalued.