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16 August, 08:29

Which one of the following stocks is correctly priced if the risk-free rate of return is 2.4 percent and the market risk premium is 7.80 percent? Stock Beta Expected Return A 0.72 8.43% B 1.48 14.00% C 1.40 13.32% D 1.06 10.58%

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  1. 16 August, 12:18
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    Stock C

    Explanation:

    In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

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

    The (Market rate of return - Risk-free rate of return) is also called market risk premium

    For Stock A

    = 2.4% + 0.72 * 7.80%

    = 2.4% + 5.616%

    = 8.016%

    For Stock B

    = 2.4% + 1,48 * 7.80%

    = 2.4% + 11.544%

    = 13.944%

    For Stock C

    = 2.4% + 1.40 * 7.80%

    = 2.4% + 10.92%

    = 13.32%

    For Stock D

    = 2.4% + 1.06 * 7.80%

    = 2.4% + 8.268%

    = 10.668%

    Since we see that the expected rate of return for stock C is equal to the expected rate of return so the stock C is correctly priced
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