GBM stock currently trades at S54 per share and is expected to trade at $62 per share in one year, the required return on the market over the same period is 12%
. Which of the following statements about GBM stock is most likely correct?
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A. B. C.A
To determine the most likely correct statement about GBM stock, we need to analyze the given information and consider the relationship between the stock's expected return and its required return, as well as its current and expected future prices.
The required return on the market is given as 12%. This represents the expected return that investors demand for investing in a diversified portfolio of stocks, considering the overall level of risk in the market.
The current price of GBM stock is $54 per share, and it is expected to trade at $62 per share in one year. We can calculate the expected return of GBM stock using the formula:
Expected Return = (Expected Future Price - Current Price) / Current Price
Expected Return = ($62 - $54) / $54 = $8 / $54 ≈ 0.1481 or 14.81%
Comparing the expected return of GBM stock (14.81%) to the required return on the market (12%), we can make the following observations:
The expected return of GBM stock (14.81%) is higher than the required return on the market (12%). This suggests that GBM stock has the potential to provide higher returns than the market average.
Since GBM stock is expected to provide higher returns than the market average, it implies that the stock has an above-average level of systematic risk. Systematic risk refers to the risk that cannot be diversified away and is inherent to the entire market. Therefore, option A, which states that GBM stock has greater than average systematic risk, is likely correct.
Now, let's analyze the valuation of GBM stock:
Undervalued: If GBM stock is undervalued, it means that the current price is lower than what is considered its fair value. However, since the expected future price of GBM stock is $62 per share, which is higher than the current price of $54 per share, it indicates that GBM stock has the potential for capital appreciation. Therefore, option A, which states that GBM stock is undervalued, is more likely correct than option B.
Overvalued: If GBM stock is overvalued, it means that the current price is higher than its fair value. However, since the expected future price of GBM stock is higher than the current price, it suggests that the stock has the potential to reach its fair value or provide a positive return. Therefore, option B, which states that GBM stock is overvalued, is less likely correct than option A.
Considering the observations made about the stock's expected return, systematic risk, and potential for capital appreciation, the most likely correct statement about GBM stock is:
A. GBM stock has greater than average systematic risk and is undervalued.