You have analyzed the following four securities and have estimated each security's beta and what you expect each security to return next year. The expected return on the market portfolio is 13%, and the relevant risk-free rate is 5.5%.
-Refer to the information above. Based on your analysis, which securities is (are)underpriced?
A)Security B and Security D
B)Security A and Security D
C)Security A only
D)Security B only

Question

You have analyzed the following four securities and have estimated each security's beta and what you expect each security to return next year. The expected return on the market portfolio is 13%, and the relevant risk-free rate is 5.5%. 
-Refer to the information above. Based on your analysis, which securities is (are)underpriced?
A)Security B and Security D 
B)Security A and Security D 
C)Security A only 
D)Security B only

Quizplus · Accepted Answer

To determine which securities are underpriced, we must compare the expected return of each security to its required return using the Capital Asset Pricing Model (CAPM). The required return is calculated as follows:

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

Using the information provided, we can calculate the required return for each security:

Security A: Required return = 5.5% + 1.2 * (13% - 5.5%) = 13.66% 
Expected return = 12.5%

Security B: Required return = 5.5% + 0.9 * (13% - 5.5%) = 11.6% 
Expected return = 10.5%

Security C: Required return = 5.5% + 1.4 * (13% - 5.5%) = 16.4% 
Expected return = 14%

Security D: Required return = 5.5% + 1.1 * (13% - 5.5%) = 12.78% 
Expected return = 11.5%

Comparing the expected returns to the required returns, we see that securities B and D have expected returns that are below their required returns, indicating that they are underpriced. Therefore, the correct answer is A) Security B and Security D.

You Have Analyzed the Following Four Securities and Have Estimated