The risk-free rate is 4%.The expected market rate of return is 12%.If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should
A)buy stock X because it is overpriced.
B)sell short stock X because it is overpriced.
C)sell short stock X because it is underpriced.
D)buy stock X because it is underpriced.

Question

Quizplus · Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the expected return on stock X = Risk-free rate + Beta * (Market return - Risk-free rate) = 4% + 1.0 * (12% - 4%) = 12%. Since the expected return of 10% is less than the CAPM expected return of 12%, stock X is overpriced, and the correct action would be to sell short.

The Risk-Free Rate Is 4