Answered

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stock a in your portfolio has a beta of 1.14 and an expected return of 16.70%. the expected return on the market (rm) is 17.50% and the risk free rate is 3.50%. your colleague tells you that based on this information stock a is underpriced (i.e., undervalued by the market).

Sagot :

The value of the expected return according to CAPM model is 19.46% and stock is overvalued.

The CAPM model allows an individual to determine the accurate rate of return for the stock the individual has purchased. It takes into account all the factors and the risks of the market. According to the CAPM model the expected return is expressed as the formula

R = Rₐ + (Rₙ - Rₐ)β

where R is the expected return, Rₐ is the risk free rate, Rₙ is the expected return on market and β is the beta of investment. now, on putting the values we get

R = 3.50% + (17.50% - 3.50%)1.14

R = 3.50% + 15.96%

R = 19.46%

Since the CAPM expected return is 19.46% and expected return given in question is 16.70% so the stock is overvalued.

Learn more about CAPM model at:

brainly.com/question/23969100

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