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2 April, 08:49

Stock A has a beta of 1.19 and an expected rate of return of 13.42 percent. The market risk premium is 8.2 percent and the risk-free rate is 4.1 percent. Which one of the following statements related to Stock A is correct? WHY?

a) stock A is overpriced?

b) Stock A is underpriced?

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Answers (1)
  1. 2 April, 09:23
    0
    The correct answer is (a) stock A is overpriced, this is because the actual rate of return is lesser than the intrinsic return rate.

    Explanation:

    Solution

    Given that:

    Stock A has beta of = 1.19

    Expected rate of return = 13.42%

    Market premium risk = 8.2%

    Risk free rate is = 4.1%

    Now

    The expected rate return = risk-free rate + beta * (market risk premium)

    =4.1 + 1.19*8.2

    = 13.858%

    Therefore, the stock A is overpriced because the actual rate of return is lower than the intrinsic return rate.
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