The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?
A) The actual expected stock return will graph above the security market line.
B) The stock is currently underpriced.
C) To be correctly priced according to CAPM, the stock should have an expected return of 13.56 percent.
D) The stock has less systematic risk than the overall market.
E) The actual expected stock return indicates the stock is currently overpriced.

Question

Quizplus · Accepted Answer

Using the capital asset pricing model (CAPM):

Expected return = Risk-free rate + Beta * (Market return - Risk-free rate)

Expected return = 3.7% + 1.24 * (11.78% - 3.7%)

Expected return = 13.56%

Since the actual expected return of the stock is 13.25%, it indicates that the stock is currently overpriced since it is not meeting the expected return according to CAPM. Therefore, the correct choice is E.

The Common Stock of Alpha Manufacturers Has a Beta of 1.24