Which one of the following stocks is correctly priced if the risk-free rate of return is 2.5% and the market risk premium is 8%? $$\begin{array} { l r c }
\underline{\text { Stock } }& \underline{ \text { Beta } }& \underline{\text { Expected Return } }\
\text { A } & .68 & 8.2 \% \
\text { B } & 1.42 & 13.9 \% \
\text { C } & 1.23 & 11.8 \% \
\text { D } & 1.31 & 12.6 \% \
\text { E } & .94 & 9.7 \%
\end{array}$$
A)A
B)B
C)C
D)D
E)E

Question

Which one of the following stocks is correctly priced if the risk-free rate of return is 2.5% and the market risk premium is 8%? $$\begin{array} { l r c } 
 \underline{\text { Stock } }& \underline{ \text { Beta } }&  \underline{\text { Expected Return } }\
\text { A } & .68 & 8.2 \% \
\text { B } & 1.42 & 13.9 \% \
\text { C } & 1.23 & 11.8 \% \
\text { D } & 1.31 & 12.6 \% \
\text { E } & .94 & 9.7 \%
\end{array}$$
A)A
B)B
C)C
D)D
E)E

Quizplus · Accepted Answer

To find the correct price, we need to use the Capital Asset Pricing Model (CAPM) formula: Expected return = Risk-free rate + Beta x Market risk premium. We can plug in the given values and solve for the expected return. For stock A, the expected return is 2.5% + 0.68(8%) = 8.44%. For stock B, the expected return is 2.5% + 1.42(8%) = 14.96%. For stock C, the expected return is 2.5% + 1.23(8%) = 12.94%. For stock D, the expected return is 2.5% + 1.31(8%) = 13.88%. For stock E, the expected return is 2.5% + 0.94(8%) = 10.22%. Therefore, stock B is correctly priced with an expected return of 13.9% which is higher than the expected returns of stocks A, C, D, and E.

Which One of the Following Stocks Is Correctly Priced If