Portfolio Management Q112
| Stock | A | B | C |
| Investor’s Estimated Return | 11.96% | 10.88% | 16.39% |
| Beta | 1.6 | 1.2 | 0.96 |
If the risk free rate is 2.20% and market return is 9.65%, which of the three securities is most likely undervalued?
- Option : C
- Explanation : For a stock to be undervalued, its estimated return should be greater than the required return (from CAPM). This condition is true only for stock C. The required return is calculated using CAPM. Required return for C = 0.022 + 0.96 * (0.0965 - 0.022) = 9.35%. Since the estimated return of 16.39% higher than the required return of 9.35%, the stock is undervalued.
