Answer-first summary for fast verification
Answer: overvalued.
The Security Market Line (SML) is derived from the Capital Asset Pricing Model (CAPM), where the expected return of a security is calculated as the risk-free rate plus the product of the stock's beta and the market risk premium. For this stock: - **Expected Return (CAPM)**: 2% (risk-free rate) + 1.3 (beta) * 5% (market risk premium) = 8.5%. Since the analyst forecasts a return of 7%, which is below the expected return of 8.5%, the stock plots **below the SML**. This indicates the stock is **overvalued** because its return is insufficient for its level of systematic risk. **Key Takeaway**: A stock is considered overvalued if its forecasted return is less than the CAPM-derived expected return, placing it below the SML.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
An analyst evaluates the security market line (SML) and a stock with the following details:
A
undervalued.
B
properly valued.
C
overvalued.
No comments yet.