Security X has an expected rate of return of 15% and a beta of 1

Finance Oct 15, 2020

Security X has an expected rate of return of 15% and a beta of 1.25. The risk-free rate is 3% and the market expected rate of return is 12%. According to the capital asset pricing model, security X has an expected return of ______________%. Is it fairly priced, overpriced or underpriced?

Expert Solution

Computation of Expected Return:

Expected Return = Rf+β*Rp

Here,

Rf = Risk-free Return

Rp = Risk Premium

Expected Return = 3%+1.25*(12%-3%)

= 3% + 11.25%

Expected Return = 14.25%

Since, share is valued at 15% expected return whereas actual expected return 14.25%. Share is underpriced.

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