Explanation:
Stock A = 8% + 1.5(7%) = 18.5%. Because the estimated return of 15.0% is less than the required return of 18.5%, Stock A is overvalued.
Stock C = 8% + 0.6(7%) = 12.2%. Because the estimated return of 14.2% is greater than the required return of 12.2%, Stock C is undervalued.
(Book 1, Module 5.2, LO 5.e)
Ultimate access to all questions.
Question 93
An analyst gathered the following data about three stocks:
| Stock | Beta | Estimated Return |
|---|---|---|
| A | 1.5 | 15.0% |
| B | 1.1 | 15.7% |
| C | 0.6 | 14.2% |
If the risk-free rate is 8% and the risk-premium on the market is 7%, are Stock A and Stock C undervalued, properly valued, or overvalued, according to the security market line (SML)?
A
Stock A: Undervalued, Stock C: Undervalued
B
Stock A: Overvalued, Stock C: Overvalued
C
Stock A: Undervalued, Stock C: Overvalued
D
Stock A: Overvalued, Stock C: Undervalued
No comments yet.