USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following information about three stocks.

-Refer to Exhibit 7.7. What is your investment strategy concerning the three stocks?
A) buy A and B; sell C
B) sell A, B, and C
C) sell A and B; buy C
D) buy A, B, and C
E) buy A and C; sell B

Question

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following information about three stocks.
 
-Refer to Exhibit 7.7. What is your investment strategy concerning the three stocks?
A) buy A and B; sell C 
B) sell A, B, and C 
C) sell A and B; buy C 
D) buy A, B, and C 
E) buy A and C; sell B

Quizplus · Accepted Answer

Both stocks A and B have a higher expected return than the market return (10%). Therefore, they are undervalued according to the CAPM (Capital Asset Pricing Model). On the other hand, stock C has a lower expected return than the market return, which means it is overvalued. Thus, it is recommended to buy stocks A and B and sell stock C to take advantage of the undervaluation/overvaluation.