Presently, the risk-free rate is 4 percent (Rf )and the expected return on the market portfolio (E(Rm))is 9 percent. Market analysts’ return expectations for four stocks are listed here, together with each stock’s beta. If the analysts’ expectations are correct, which stocks (if any) are overvalued? Which (if any) are undervalued? (Hint: You need to calculate the required return on each stock) Stocks Expected Return Beta Required Rate Return Underpriced? Overpriced? Or Correctly Priced? 1. General Motors (GM) 5.10% 1.2 2. McDonald's Corp (MCD) 7.60% 0.72 3. Boeing Company (BA) 13.20% 1.5
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Presently, the risk-free rate is 4 percent (Rf )and the expected return on the market portfolio (E(Rm))is 9 percent. Market analysts’ return expectations for four stocks are listed here, together with each stock’s beta.
If the analysts’ expectations are correct, which stocks (if any) are overvalued? Which (if any) are undervalued?
(Hint: You need to calculate the required return on each stock)
| Stocks | Expected |
Beta | Required Rate Return |
Underpriced? Overpriced? Or Correctly Priced? |
|
| 1. General Motors (GM) | 5.10% | 1.2 | |||
| 2. McDonald's Corp (MCD) | 7.60% | 0.72 | |||
| 3. Boeing Company (BA) | 13.20% | 1.5 |
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