The beta of Stock A is 2.1. The risk-free rate is 6 percent, and the market return is 13 percent. The expected rate of return of Stock A is 15.5 percent. Based on the above information, which of the following statements is true?
A)An investor should buy Stock A because its expected rate of return is less than the required rate of return.
B)An investor should buy Stock A because its expected rate of return is greater than the required rate of return.
C)An investor should not buy Stock A because its expected rate of return is greater than the required rate of return.
D)An investor should not buy Stock A because its expected rate of return is less than the required rate of return.
E)An investor should be indifferent towards buying or selling the stock.

Question

Quizplus · Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Substituting the given values: Required Return = 6% + 2.1 * (13% - 6%) = 6% + 2.1 * 7% = 6% + 14.7% = 20.7%. Since the expected rate of return of Stock A (15.5%) is less than its required rate of return (20.7%), statement D is correct.

The Beta of Stock a Is 2