You determine that LMN common stock has an expected return of 24%.LMN has a Beta of 1.5.The risk-free rate is 5%,and the market expected return is 15%.Which of the following is most likely to happen?
A) You and other investors will buy up LMN stock and its price will rise.
B) You and other investors will sell LMN stock and its return will fall.
C) You and other investors will buy up LMN stock and its return will rise.
D) You and other investors will sell LMN stock and its price will fall.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected return of a stock can be calculated using the formula: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). For LMN, the expected return using CAPM would be 5% + 1.5 * (15% - 5%) = 20%. However, the actual expected return is 24%, which is higher than the CAPM prediction. This indicates that the stock is undervalued, leading investors to buy the stock, causing its price to rise until the expected return aligns with the CAPM prediction.

You Determine That LMN Common Stock Has an Expected Return