Question

Stock Y has a beta of 1.15 and an expected return of 11.8 percent. Stock Z has a beta of .85 and an expected return of 10.7 percent. If the risk-free rate is 4.5 percent and the market risk premium is 7.1 percent, are these stocks correctly priced?

Answer 1

Expected return = risk free rate + beta * market risk premium

=>

expected return of Y = 4.5% + 1.15 * 7.1%

= 12.665%

= 12.67%

expected return of Z = 4.5% + 0.85 * 7.1%  

= 10.535%

= 10.54%

No, the stocks are not correctly priced as the expected return doesn't match the CAPM return