Question

The expected return on the market portfolio is 13%. The risk-free rate is 6%. The expected return on SDA Corp. common stock is 12%. The beta of SDA Corp. common stock is 1.50. Within the context of the capital asset pricing model, _________.A) SDA Stock is underpricedB) SDA stock is fairly pricedC) SDA Corp. stock's alpha is

Answer 1

Answer: C) SDA Corp. stock's alpha is -4.5%

Step-by-step explanation:

Calculate the required return using the Capital Asset Pricing Model.

= risk free rate + beta ( market return - risk free rate)

= 6% + 1.5 (13% - 6%)

= 6% + 10.5%

= 16.5%

The expected return on the stock is 12% yet the required return is 16.5%. This means that this stock is overpriced because it is giving a return less than what it should be giving.

The alpha is therefore;

= Expected return - Required return

= 12% - 16.5%

= - 4.5%