The risk-free rate is 4%.The expected market rate of return is 11%.If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should
A)buy CAT because it is overpriced.
B)sell short CAT because it is overpriced.
C)sell short CAT because it is underpriced.
D)buy CAT because it is underpriced.

Question

Quizplus · Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the expected return on CAT can be calculated as: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate) = 4% + 1.0 * (11% - 4%) = 11%. Since the expected return of CAT (10%) is less than the CAPM expected return (11%), CAT is overpriced, and the correct action would be to sell short.

The Risk-Free Rate Is 4