The risk-free rate is 7 percent.The expected market rate of return is 15 percent.If you expect stock X with a beta of 1.3 to offer a rate of return of 12 percent,you should
A) buy stock X because it is overpriced.
B) sell short stock X because it is overpriced.
C) sell stock short X because it is underpriced.
D) buy stock X because it is underpriced.
E) none of these,as the stock is fairly priced.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected rate of return for stock X would be 16.6% [7% + 1.3(15%-7%)]. Since the expected rate of return for stock X is lower than the CAPM's expectation, it suggests that stock X is overpriced. Therefore, the best choice would be to sell short stock X.

The Risk-Free Rate Is 7 Percent