Assume the risk-free rate is 4.5% and the expected return on the market is 11%. You anticipate Stock XYZ to sell for $28 at the end of next year and pay a dividend of $2. The stock is currently selling for $26.50 with a beta of 1.2. You currently hold stock XYZ in a well-diversified portfolio. Assuming you have money to invest, what should you do?
A) Buy stock XYZ.
B) Sell stock XYZ.
C) Do nothing because it is properly valued.
D) Invest your money in the risk-free rate of return.
E) Choices c and d.

Question

Quizplus · Accepted Answer

The expected return for stock XYZ is (28.00 - 26.50 + 2.00)/26.50 = 0.132.
The required return based on the CAPM is .045 + 1.2(.11 - .045) = 0.123.
The expected return for next period is greater than the required return based on the CAPM.

Assume the Risk-Free Rate Is 4