Assume the following data for a stock: Beta = 0.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 10%.Then the stock is:
A)overpriced.
B)underpriced.
C)correctly priced.
D)cannot be determined.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on a stock should be equal to the risk-free rate plus the stock's beta multiplied by the difference between the market rate of return and the risk-free rate. 
In this case, the expected rate of return on the stock is 10%, which is lower than what the CAPM would predict (i.e., 4% + 0.5*(12% - 4%) = 8%). Therefore, the stock is underpriced since it has the potential to provide a higher return than its current price suggests.

Assume the Following Data for a Stock: Beta = 0