The market rate of return is 12% and the risk-free rate of return is 4%. A stock that has 5% more risk than the market has an actual return of 12%. Given this information, the stock is underpriced.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected return of a stock is determined by its beta (a measure of its risk relative to the market), the risk-free rate, and the market rate of return. A stock with 5% more risk than the market does not directly translate to being underpriced or overpriced without knowing its beta and how that risk translates to expected return. Additionally, if a stock's actual return is equal to the market rate of return, without knowing its expected return based on its specific risk level (beta), we cannot determine if it is underpriced or overpriced. The information given does not provide enough detail to make this determination.

The Market Rate of Return Is 12% and the Risk-Free