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Hello Sir,
I hope you would be fine. I have a question for you.An investor has forecasted following information for two stocks, namely, X and Y:
Description X Y
Expected return 20% 20%
Standard deviation 20% 30%
Beta 1.5 2
T-Bill rate 5.5%
Market risk premium 8.5%
Required:
Label each stock as undervalued, or overvalued, by showing appropriate computations.Kindly help me to solve this question. Thanks in advance.
Calculations involving the standard deviation are not examinable in Paper F9.
However, assuming you have watched my free lectures on CAPM you should be able calculate the theoretical required return using the normal CAPM formula.
If the actual return is higher than the theoretical return then the stock is undervalued; if it is lower than the theoretical return then it is overvalued.
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