Question

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.6 percent and the market risk premium is 8.1 percent?

Stock Beta Expected Return
A. 89 7.83%
B. 1.52 12.59
C. 1.25 11.27
C 1.27 14.50
D. 80 10.08

Answer 1

Answer: Stock of D is correctly priced at 10.08%

( for the beta of Stock A and D, I guessed you meant 0.89 and 0.80 respectively as opposed to 89 and 80 you put, so i corrected and solved accordingly.)

Step-by-step explanation:

Expected return = Rf + beta ( Rm - Rf )

Rf =Risk free return = 3.6

Rm-Rf = Market risk premium = 8.1%

A) Stock Beta , Expected Return= 0.89, 7.83%

Expected return = 3.6 + 0. 89 (8.1) = 10.809%-- its over priced

B) Stock Beta , Expected Return= 1.52 12.59%

Expected return = 3.6 + 1.52(8.1) = 15.912%---- its over priced

B) Stock Beta , Expected Return= 1.25 11.27%

Expected return = 3.6 + 1.25(8.1) = 13.725 %--- its overpriced

c) Stock Beta , Expected Return= 1.27 14.50%

Expected return = 3.6 + 1.27(8.1) = 13.887%---- Its underpriced

d) Stock Beta , Expected Return= 0.80 10.08%

Expected return = 3.6 + 0. 80(8.1) = 10.08%---- Correctly priced