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The expected return on the market portfolio is 15%. The risk-free rate is 8%. The return on SDA Corp. common stock turned to be 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, ____. SDA Corp.

A. stock is underpriced SDA Corp.
B. stock is fairly priced SDA Corp.
C. stock's alpha is -0.75% SDA Corp.
D. stock alpha is 0.75%

Respuesta :

Answer:

C. stock's alpha is -0.75% SDA Corp.

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

For computing the price of the stock, first we have to compute the Expected rate of return which is shown below:

= 8% + 1.25 × (15% - 8%)

= 8% + 1.25 × 7%

= 8% + 8.75%

= 16.75%

Now the price would be

= Return on common stock - expected rate of return

= 16% - 16.75%

= -0.75%

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