- CFA Exams
- CFA Level I Exam
- Study Session 9. Equity Valuation (1)
- Reading 25. Return Concepts
- Subject 1. Return concepts

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**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:

A. 10%

B. 15%

C. 20%

**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%.

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**User Contributed Comments**
13

User |
Comment |
---|---|

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%=> expected=15% |

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 x=> 0.2 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%) |