Question

Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _________. A. fairly priced B. overpriced C. underpriced D. none of these answers

Answer 1

Answer: overpriced

Explanation:

The Security Market Line (SML) is a graphical representation of the relationship between the expected return on an asset and its systematic risk.

From the above question, the rate of return will be:

= 0.05 + 1.15 (0.15 - 0.05)

= 0.05 + 1.15(0.1)

= 0.05 + 0.115

= 0.165

= 16.5%

Since the return which is 16.5% is more than the expected rate of return which is 13%, then the security is overpriced.