You are an investment advisor who believes that the capital asset pricing model will hold in the long run for all stocks. You have current holdings of two stocks, A and B, with the following characteristics: 

Stock Expected        Return Beta 

A                 14%              1.2x 

B                18%               2.9x 

The current risk-free rate is 4% and the expected return on the market is 10%. 

Required: 

(a) For each of these stocks i) show that they are or are not in equilibrium, ii) are over-priced or under priced and iii) indicate how you would change your holdings (i.e. would you sell or buy more?) 

(b) For Stock B only, calculate the price you would be willing to pay assuming the most recent dividend was $1.35 and the growth rate is 5%.

Answer rating: 100% (QA)

Solution Given data Particulars Stock A Stock B Expected returnR 14 18 Beta 12 29 Risk free rate of ... View the full answer