Explanation:
CAPM required return = $0.01 + 1.3(0.06 - 0.01) = 0.075 = 7.5%$
According to the analyst's estimates, the security is overvalued because the forecasted return (7%) is less than the required return (7.5%).
(Book 1, Module 5.2, LO 5.e)
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Question 15
An analyst observes that the beta of a traded security is 1.3, the market return is 6%, and the risk-free rate is 1%. The analyst forecasts that the security will yield a 7% return over the next year. Based on these assumptions, the security is:
A
overvalued, because the forecasted return exceeds the required return.
B
undervalued, because the forecasted return exceeds the required return.
C
undervalued, because the required return exceeds the forecasted return.
D
overvalued, because the required return exceeds the forecasted return.
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