CFAI BK6, RD.68 Ques always, return

jcole21

CFAI Book 6, RD.68, PG. 580, Q16
CAPM is 10.9%, forecasted return is 9%.
I always get this confused. According to the book, since the forecasted return is below the CAPM, it is overvalued.
Why is it overvalued? If it lies below SML shouldn’t it be undervalued?
Thanks!

hariRaj

what do you use the rate of return for?
you discount cash flows at it…
10.9 % will give you a lower number, when compared to 9% for the discount rate.
so the 9% is overvalued.

cv4cfa

One easier way to remember is
CAPM return is based on stock’s beta i.e. stock’s systematic risk. CAPM return is the return that should come out coz of the risk involved.
Forecasted Return is based on how the scenario looks like and what will probably be the outcome.
When actual(forecasted)
I myself forget SML above and below thing so cant really help with that.