Portfolio Management - Portfolio Management Section 1
71. Information about three stocks is provided below:
| Stock | Expected Return | Beta |
| ABC Corp. | 6% | 0.7 |
| KLM Corp. | 10% | 1.0 |
| XYZ Corp. | 16% | 1.5 |
If the expected market return is 10% and the average risk-free rate is 2%, according to the capital asset pricing model (CAPM) and the security market line (SML), which of the three stocks is most likely undervalued?
- Option : C
- Explanation : Calculate the required return for the three stocks and compare them with the expected return to see which one is undervalued. For XYZ the required return = 2 + 1.5 x (10 – 2) = 14. XYZ Corp. is undervalued, because it lies above the SML. The expected return, 16%, is more than the required return of 14%.
72. Which of the following statements is least likely to be correct about
Jensen’s alpha?
- Option : C
- Explanation : Jensen’s alpha represents the excess risk-adjusted return of a portfolio and is based on systematic risk.
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