Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:
A) is underpriced.
B) is correctly priced.
C) will plot below the security market line.
D) will plot on the security market line.
E) will plot to the right of the overall market on a security market line graph.

Question

Quizplus · Accepted Answer

The expected return based on the Capital Asset Pricing Model (CAPM) is calculated using the formula: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Lexant stock has 2% less systematic risk than the market, implying a beta of 0.98. The expected return is 3.2% + 0.98 * (10.1% - 3.2%) = 9.804%. Since the actual return of 10.2% is higher than the expected return, the stock is underpriced.

Assume the Market Rate of Return Is 10