Question

Assume the risk-free rate is 4.5 percent and the expected return on the market is 11 percent. You anticipate Stock XYZ to sell for $28 at the end of next year and pay a dividend of $2. The stock is currently selling for $26.50 with a beta of 1.2. You currently hold stock XYZ in a well-diversified portfolio. Assuming you have money to invest, you should

Answer 1

Purchase the stock

Step-by-step explanation:

The computation is shown below:

the Expected return or HPR is

= ( Future price - Current price + Dividend) ÷ Current price

= ($28 - $26.5 + $2) ÷ 26.5

= $3.5 ÷ 26.5

= 13.21%

The Expected return using CAPM is

= Risk free rate + BEta × (Market return - Risk free rate)

= 4.5 + 1.2 × (11 - 4.5 )

= 4.5 + 1.2 × 6.5

= 4.5 + 7.8

= 12.30%

As we can see that holding period return is more than the capm return that means it beaten the market so here we should purchase the stock