CFA Practice Question
There are 57 practice questions for this study session.
CFA Practice Question
The market price of a stock is $20 now. The required rate of return is 10%. The intrinsic value, however, should be $22. If the price is going to converge to value in half a year, then the expected rate of return for the period will be approximately:
Explanation: The stock is undervalued by $2, or 10%. The required rate of return for half a year is approximately 5%. The expected rate of return = required return 5% + 10% = 15%.
User Contributed Comments 13
|pjdeschenes||I don't get this. The expected return should just be the ex-ante holding period return: 10%. The question prompt doesn't say anything able annualizing the rate of return.|
|ljamieson||no kidding, I didn't get it either. I think it's that subtle difference between actual return and required return.|
|fanfanli||The security would still be expected to return at least the expected rate of return, ignoring any returns gained from mispricings|
|aggabad||ex ante= expected - required, 10%=expected-5%=>
|PRICHARD||Can some one explain in a more detailed way? I really dun know wats going on. Thanks.|
|NillePet||expeted return = required return + undervaluation.
reg. return for 6m = 5%
undervaluation = 2/20 = 10%
Thus expected return =15%
|LloydBraun7||The stock will converge to value (appreciate 10%) but on top of that will also appreciate by the required rate of return (5% over period).|
|broadex||Expected price= Required rate of return (5%) plus undervaluation (10%)|
|evanli1||easier way: 20 = 2/ 0.1 (2 =D1)
now Intrinsic 22 = (2 + x) / 0.1
0.2/20 is an additional yield of 10% per year/5% semiannual
required return = 10% + additional 5%
|Shortseller||They assume you get the required half year return ON TOP of the reversion to the intrinsic value.|
|Shortseller||Also technically you would not get 5% you would get 4.8 for the semi annual return.
This is because (1+5%)^2 does not equal 10%.
|something2||Good question - un annualize the required rate of return|
|Amir1||- Exp alpha = Exp return - Required return
- Rearrange: Exp return = Exp alpha + Req return
- Expected return = 2/20 + .10/2 = 15%
(expected alpha or how much it's undervalued is $2 divided by mkt price 20) + (semi-annual required rate of return 10%/2=5%)