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The following information is available with regard to market (M) and different common stocks
The following information is available with regard to market (M) and different common stocks. Information regarding the market (According to your analysis) Equation for the SML is Ri = 10 + 9/Ji Variance of returns of the market = 64 Information regarding the common stocks (According to your analysis)
|
Common Stock |
Covar ;,M |
Implied/Expected Return(%) |
|
A |
64 |
18 |
|
B |
96 |
24.5 |
|
C |
-32 |
6 |
|
D |
0 |
10 |
Identify the stocks which are mispriced
Expert Solution
Given that SML is 10 + 9*Beta
We know that Beta = Covariance SM / Variance of market
|
Stock (1) |
Covariance (2) |
Implied return (3) |
Beta (4) = (2)/64 |
SML Return (5) = 10 + 9*(4) |
Pricing (3) ≠(5) |
| A | 64 | 18 | 1 | 19 | Mispriced |
| B | 96 | 24.5 | 1.5 | 23.5 | Mispriced |
| C | -32 | 6 | -0.5 | 5.5 | Mispriced |
| D | 0 | 10 | 0 | 10 | Fair Priced |
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