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Stock Valuation

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Stock A has a beta of 1.1 and an expected return of 12%. Stock B has a beta of .92 and an expected return of 10.25%. The risk-free rate is 3.5% and the expected return on the market is 11%.Are these stocks correctly priced? Why or why not?

1. No; Stock A is underpriced and stock B is overpriced.

2. No; Stock A is overpriced and stock B is underpriced.

3. No; Stock A is overpriced but stock B is correctly priced.

4. No; Stock A is underpriced but stock B is correctly priced.

5. Yes; Both stocks are correctly priced.

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Solution Summary

The solution explains how to calculate the value of a stock and check if it is correctly priced.

Solution Preview

We calculate the returns using the CAPM and then compare with the expected return
Using CAPM
Required return = Rf + (Rm-Rf) X beta
Stock ...

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