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**CFA Practice Question**

A stock has a beta of 1.2. the market risk premium is 6%, and the risk-free rate is 3%. The market price of this stock is lower than the price obtained from CAPM. The market estimates the expectations and correlations of the future cash flows correctly; it is in the discount rate for these cash flows that it differs from the discount rate suggested by CAPM. The expected return for a trader who buys this stock is:

A. greater than 10.2%

B. less than 10.2%

C. equal to 10.2%

**Explanation:**The CAPM discount rate is 10.2%. If the price was according to CAPM, then the expected return would have been 10.2%. As the market price is lower, it implies that the expected return will be higher.

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**User Contributed Comments**
2

User |
Comment |
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sh21 |
this was tricky, i guessed between A and C and got it right I suppose the key word here is market price in LOWER hence ER will he HIGHER! |

jasmine23 |
I think it is because it is an undervalued stock. So, we will have higher than expected return. |