Stocks expected return is 10% and CAPM return calculated is 11%. Is the stock overvalued or undervalued?
undervalued! You should Buy it.
really?..I thought that if the stock was required to earn 11% through the CAPM and it was only expected to return 10% you would not buy it… I guess I need to go back to my books from L1?
You don’t need to do the reading, Salman does. The stock is overvalued because a lower expected return than what CAPM suggests means you’re taking on too much inherent risk for too low of a return.
Verse…Tks…I was trying to be diplomatic!
If I am reading it right the below equation has the key: Expected return = Alpha + CAPM return ==> 11 = 1 + 10 If you have +ve alpha it is undervalued.
That is it…Think of it this way…the capm is the required return…as you have shown above the expected is above required…therefore you would buy the “undervalued” stock. Note: to avoid confusion,you now have the 11 & 10% the different way from your first post in this thread.
overvalued. you’re only getting 10% when CAPM is calling for 11%. the alpha is -1, per your 1st post. if the alpha is positive, per your 2nd post, then it will undervalued and should be bought.
Perdition, thanks for the correction. The equation should be: Expected return = Alpha + CAPM return ==> 10 = -1 + 11 This is -ve alpha ==> overvalued. Thanks!