question archive The stock of WeAllWantToBeFinanceStudents Company has a beta of 1
The stock of WeAllWantToBeFinanceStudents Company has a beta of 1
Subject:BusinessPrice:3.87 Bought7
The stock of WeAllWantToBeFinanceStudents Company has a beta of 1.2. The current risk-free rate of return is 3.2% and the market risk premium is 4%.
a) What is the required rate of return on this stock?
b) If the expected rate of return is 7%, is this a good buy or a bad buy?
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Answer:
beta of stock = 1.2
Current risk free rate(RFR) = 3.2%
Market risk premium = 4%
(a) Rate of return (R) = RFR + beta * market risk premium
= 3.2 + 1.2*4
= 3.2 + 4.8 = 8%
(b) Expected rate of return = 7%
whereas
required rate of return = 8%
When expected return is less than the required rate of return , it means the sewcurity is overvalued and needs to be sold. So , its a bad buy.
