Question

4. Your company’s financial analysts have provided some data for a stock (IBM), the market, and a risk-free asset. Answer the following question using the information that they have provided:

Asset Return             Variance   

IBM   0.20                 0.16

S&P 500 0.30                 0.25

Risk-free asset 0.06                 0.00

Covariance (IBM and S&P) 0.18

If the beta of IBM is 0.72, which of the following statements is true?

Group of answer choices

a. IBM's return should be 16.0; the stock is overvalued.

b. IBM's return should be 16.0; the stock is undervalued.

c. IBM's return should be 23.3; the stock is overvalued.

d. IBM's return should be 23.3; the stock is undervalued.

Answer 1

4)

first we have to find beta of the IBM stock from above data

Beta = Covariance (IBM and S&P) / variance of S&P

= 0.18 / 0.25

So , Beta = 0.72 (eventhough already given in question.i am just showing calculation)

As per CAPM required return = Rf + Beta*(Rm - Rf)

where , Rf = risk free rate

Rm = market return (S&P)

Return = 6% + 0.72*(30% - 6%)

= 23.80%

As per CAPM return Should be 23.80% but Actual return given is 20% so IBM stock is over priced

Option C is correct

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