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.
User Contributed Comments 2
| User | Comment |
|---|---|
| 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. |