Donald Northerland forecasts the stock return, beta, and standard deviation for three stocks: Cayman, Bonaire, and Lucia. The expected return and standard deviation for the broad market equal 12% and 20%, respectively. The risk-free rate equals 5%.
Using the capital asset pricing model, determine which of the following statements is least likely correct.
Click on the arrows to vote for the correct answer
A. B. C.A
To determine whether a stock is overvalued or undervalued, we can use the Capital Asset Pricing Model (CAPM), which relates the expected return of a stock to its beta and the market risk premium. The market risk premium is the difference between the expected return of the market and the risk-free rate.
Given information:
To apply the CAPM, we need the beta and standard deviation for each stock. Let's analyze each statement and determine which one is least likely to be correct.
A. Cayman is overvalued. If Cayman is overvalued, it means its expected return is lower than what the CAPM predicts. In other words, its expected return is lower than the return based on its beta and the market risk premium. However, we don't have information about Cayman's expected return, beta, or standard deviation. Therefore, we cannot determine whether Cayman is overvalued or not based on the given information.
B. Bonaire is undervalued. If Bonaire is undervalued, it means its expected return is higher than what the CAPM predicts. Again, we don't have information about Bonaire's expected return, beta, or standard deviation. Therefore, we cannot determine whether Bonaire is undervalued or not based on the given information.
C. Lucia is overvalued. If Lucia is overvalued, it means its expected return is lower than what the CAPM predicts. Similarly, we don't have information about Lucia's expected return, beta, or standard deviation. Therefore, we cannot determine whether Lucia is overvalued or not based on the given information.
In summary, based on the given information, we cannot determine whether any of the stocks (Cayman, Bonaire, or Lucia) are overvalued or undervalued. Therefore, the least likely correct statement is A. Cayman is overvalued, as we don't have the necessary information to make that determination.