You are analyzing a stock that has a beta of 1.18. The risk-free rate is 4.1% an

Question

You are analyzing a stock that has a beta of 1.18. The risk-free rate is 4.1% and you estimate the market risk premium to be 7.3%. If you expect the stock to have a return of 10.9% over the next year, should you buy it? Why or why not?

The expected return according to the CAPM is ___% (Round to two decimal places)

Should you buy the stock? (Select the best choice below)

A. Yes, because the expected return based on the beta is equal to or less than the return on the stock.

B. No, because the expected return based on the beta is greater than the return on the stock.

Explanation / Answer

As per CAPM, expected return = Risk Free Rate + Market Risk Premium * Beta

Expected Return = 4.1% + 7.3% * 1.18 = 12.714%

Actual expected Return = 10.90%

Since the expected return is higher than expected return as per market situation, the stock should not be bought since the stock would be overpriced in the market currently.

B. No, because the expected return based on the beta is greater than the return on the stock.

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.