84.9k views
0 votes
The expected return on the market portfolio is 18%. The risk-free rate is 10%. The expected return on SDA Corp. common stock is 17%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, _________.

User Jridyard
by
9.3k points

1 Answer

4 votes

Final answer:

Using the Capital Asset Pricing Model (CAPM), the expected return for SDA Corp. should be 20%. The stock may be underpriced as its actual expected return is 17%, lower than the CAPM value.

Step-by-step explanation:

The question posed relates to the Capital Asset Pricing Model (CAPM) which calculates the expected return of a security based on its risk in relation to the market. In this instance, SDA Corp. has an expected return of 17%, a beta of 1.25, the risk-free rate is 10%, and the expected return on the market portfolio is 18%. According to CAPM, the expected return on a security is the risk-free rate plus the product of the security's beta and the market risk premium (the difference between the market return and the risk-free rate).

To better understand this concept, let's calculate the expected return using the CAPM formula:

Expected return = Risk-free rate + (Beta × (Market return - Risk-free rate))

Inserting the given values we get:

Expected return = 10% + (1.25 × (18% - 10%))

Expected return = 10% + (1.25 × 8%)

Expected return = 10% + 10%

Expected return = 20%

Comparing this to the actual expected return of SDA Corp. (17%), we can see that SDA Corp.'s common stock may be underpriced, according to CAPM, because its expected return is lower than what CAPM suggests it should be, implying the potential for a higher actual rate of return.

User AnyDozer
by
8.7k points
Welcome to QAmmunity.org, where you can ask questions and receive answers from other members of our community.

9.4m questions

12.2m answers

Categories