Asked by Ouita Weeden-Dawson on Jun 23, 2024
Verified
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 11%, you should
A) buy CAT because it is overpriced.
B) sell short CAT because it is overpriced.
C) sell short CAT because it is underpriced.
D) buy CAT because it is underpriced.
E) None of the options, as CAT is fairly priced.
Risk-Free Rate
The expected yield from an investment that carries no risk of losing money, often shown through the interest rates of government securities.
- Evaluate investment opportunities using the concept of underpricing and overpricing relative to the Security Market Line (SML).
Verified Answer
CD
Chanese DelancyJun 26, 2024
Final Answer :
E
Explanation :
Given CAT's beta of 1.0, its expected rate of return aligns with the market rate of return (11%), indicating it is fairly priced according to the Capital Asset Pricing Model (CAPM).
Learning Objectives
- Evaluate investment opportunities using the concept of underpricing and overpricing relative to the Security Market Line (SML).