The risk-free rate is 4.2 percent and the expected return on the market is 12.3

Question

The risk-free rate is 4.2 percent and the expected return on the market is 12.3 percent. Stock A has abe ta of 1.2 and an expected return of 13.1 percent. Stock B has a beta of 0.87 and an expected return of 11.4 percent. Are these stocks correctly priced? Why or why not?
Answer
No; Stock A is underpriced and stock B is overpriced.
No; Stock A is overpriced and stock B is underpriced.
No; Stock A is overpriced but stock B is correctly priced.
No; Stock A is underpriced but stock B is correctly priced.
Yes; Both stocks are correctly priced

Explanation / Answer

12.3 - 4.2 = 8.1 market premium 1.2 beta * 8.1 = 9.72 0.87 beta * 8.1 = 7.047 Add back the 4.2 risk free and you get 13.92 and 11.247 Stock A is overrated while Stock B is underrated

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