土豆妮

Raj Shankar is a security analyst who uses the capital asset pricing model (CAPM) to determine the fair valuation for stocks. Recently, Shankar examined the prospects for Mini Software Solutions (MSS), a small software company operating in Southern California. Shankar makes the following forecasts for MSS and for the broad market: 

• Shankar’s forecasted return for MSS: 11%
• Shankar’s forecasted beta for MSS: 1.25
• Expected return on the stock market index: 12%
• Risk-free rate: 4%

Using his framework of analysis, Shankar should derive the following expected return and buy/sell recommendation for MSS:

Expected Return

Recommendation

A) 10% Sell

B) 14% Sell

C) 14% Buy

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The equation for the (CAPM) is:

E(R) = R_F + β[E(R_m) – R_F] = 0.04 + 1.25[0.12 – 0.04] = 0.14 = 14%.

Shankar’s forecasted (11%) is less than the equilibrium expected (or required) return for MSS. Therefore, Shankar should make a sell recommendation on the stock.

土豆妮

The market is expected to return 15% next year and the risk-free rate is 7%. What is the expected rate of return on a stock with a beta of 1.3?

A) 17.1.

B) 10.4.

C) 17.4.

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ER_stock = R_f + ( ER_M ? R_f ) Beta_stock

土豆妮

What is the expected rate of return for a stock that has a beta of 0.8 if the risk-free rate is 5%, and the market risk premium is 7%?

A) 6.6%.

B) 8.0%.

C) 10.6%.

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ER_stock = 0.05 + 0.8(0.07) = 10.6%

土豆妮

What is the expected rate of return for a stock that has a beta of 1.2 if the risk-free rate is 6% and the expected return on the market is 12%?

A) 7.2%.

B) 12.0%.

C) 13.2%.

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ER_stock = 0.06 + 1.2(0.12 ? 0.06) = 13.2%