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1) From the following information, determine whether or not stock B is over- or under-valued
1) From the following information, determine whether or not stock B is over- or under-valued. Why?
2)Referring to the information given above, how will stock B move toward the equilibrium price?
From the following information, determine whether or not stock B is over- or under-valued. Why? Risk-free rate is 6% and the market return is 9% Stock A Stock B Beta 0.70 1.00 Actual Return 6.20% Stock 1.15 15.15% Stock D 1.40 5.15% Stock E -3.30 6% 8% Referring to the information given above, how will stock B move toward the equilibrium price?
Expert Solution
1. If actual retrun is greater than required rate of return, the stock is undervalued
If actual retrun is lower than required rate of return, the stock is overvalued
Stock B, required arte of return=risk free rate+(beta*(market return-risk free rate))=6%+(1*(9%-6%))=6%+3%=9%
Actual return is lower than required arte of return (6.2%<9%). Hence, it is overvalued.
2. As the stock B is overvalued, it moves downwards to reach equilibrium price.
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