Question

What exactly do we mean when we say that a stock is “fairly priced?” Again, please be specific.

Explain what happens to the “efficient frontier” when we add the possibility of lending and borrowing at the risk-free rate. Please be specific.

Answer 1

Answer:-

When the stock is trading at a price (market price) is equal to the model price ( the price implied by a dividend discount model or free cash flow valuation model), the stock is considered to be fairly price.

By adding the possibility of lending and borrowing at risk free asset to the efficient frontier, we get one portfolio that belongs to both efficient frontiers ie with risk and without risk.  We get a tangency portfolio which contains only risky assets. The Line I contains only risky assets. In this image we add risk free rate to the port X , Y and Z. The X - axis is standard deviation and Y-axis is mean.

101 0.094 pline I t good 0.07+ ooby Tangeny 0'05+ ht RF 0.024 00)| 0 0 05 Our Loirs, diz 025 03. Standard deviation