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A security’s required return can be predicted using CAPM using formula
Rj = Rf + beta j (Rm – Rf)
Security x has a beta value of 1.6 and provides a return of 12%
Secuirty Y has a beta value of 0.9 and provides a return of 13%
secuity z has a beta value of 1.2 and provides a return of 13.2%Security z is correctly priced. The risk free return is 6%.
determine whether security x is over priced or under priced, and whther secuity y is over priced or under priced
Sir in the above question as question says that security z is correctky priced so I have calculated following figures
Rm = 12%
Return on security x = 15.6%
Return on security y = 11.4%Sir by looking these figures how we can determine that which security is over priced and which is under priced?
If a security is actually giving a lower return that it should be giving, then it means that is currently over priced.
Security X should end up giving 15.6%, and a higher return always means a lower market value (because the market value is the future receipts discounted at the required return). So X’s market value will fall, which means that currently it is over priced.The opposite applies when the actual return is higher that the return that it should be giving.
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