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12 April, 11:23

3. The risk-free rate is 3.7 percent and the expected return on the market is 12.3 percent. Stock A has a beta of 1.1 and an expected return of 13.1 percent. Stock B has a beta of. 86 and an expected return of 11.4 percent. Are these stocks correctly priced

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  1. 12 April, 13:27
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    Stock A is not appropriately priced as the expected return of 13.1%is less than the one calculated at 13.2%

    Stock B is not appropriately priced as the expected return of 11.4%is less than the one calculated at 11.10%

    Explanation:

    The expected return on stock can be computed as follows:

    Ke=Rf+beta * (Market return-Rf)

    Rf is the risk free rate of 3.7%

    beta is 1.1

    expected return is 13.1% as calculated

    expected return is then calculated using the formula above

    Ke=3.7%+1.1 * (12.3%-3.7%)

    Ke=13.16% approx. 13.2%

    For stock B:

    Beta is 0.86

    expected return is 11.4%

    Ke=3.7%+0.86 (12.3%-3.7%)

    Ke=11.10%
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