The risk-free rate is 4 percent.The expected market rate of return is 11 percent.If you expect CAT with a beta of 1.0 to offer a rate of return of 13 percent,you should
A)buy CAT because it is overpriced.
B)sell short CAT because it is overpriced.
C)sell stock short CAT because it is underpriced.
D)buy CAT because it is underpriced.
E)none of the above,as CAT is fairly priced.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected rate of return for an asset can be calculated as:
Expected Return = Risk-Free Rate + Beta x (Market Return - Risk-Free Rate)
Plugging in the given values, we get:
Expected Return = 4% + 1.0 x (11% - 4%) = 11%
Since the expected rate of return for CAT is higher than its required rate of return (which is 11%), it is considered underpriced. Therefore, buying CAT would be a good choice as it has the potential to offer a higher return than the market.

The Risk-Free Rate Is 4 Percent