The risk-free rate is 5% and the expected rate of return on the market portfolio is 10%

Finance Nov 12, 2020

The risk-free rate is 5% and the expected rate of return on the market portfolio is 10%.
a. Calculate the required rate of return on a security with a beta of 1.23. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
Required return

b. lithe security is expected to return 12%. is it overpriced or underpriced?

Expert Solution

a. Computation of Required Rate of Return as per Capital Asset Pricing Model(CAPM):

Required Rate of Return(R_j) = R_f+ Beta* (R_m-R_f)

Here,

R_f= Risk-free Rate of Return = 5%

R_m=Rate of Return in Market Portfolio = 10%

Beta = 1.23

Required Rate of Return(R_j) = 5%+1.23(10%-5%)

= 5% + 6.15%

= 11.15%

b. Since the required rate of return(11.15%) is less than expected rate of return(12%), the security is under priced.

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