Following is the data regarding Three Securities. Stock Expected Return (%) Std. deviation Correlation with the Market return A 19% 2.50 0.840 B…

(i) To decide which of this security is over, under or correctly valued we need to compute the Required Rate of Return of each Stock using CAPM for which Beta shall be calculated as follows: Beta of Stock A (β A ) = 0.840 X 2.50 / 1.20 = 1.75 Beta of Stock B (β B ) = 0.540 X 2.00 / 1.20 = 0.90 Beta of Stock C (β C ) = 0.975 X 0.80 / 1.20 = 0.65 Required rate of return is given by CAPM R j = R f + β (R m -R f ) For Stock A R A = 9% + 1.75 (14% - 9%) = 17.75% Stock B R B = 9% + 0.90 (14% - 9%) = 13.50% Stock C R C = 9% + 0.65 (14% - 9%) = 12.25% Stock Required rate of return % Expected rate of return % Valuation A 17.75% 19.00% Under Valued B 13.50% 13.50% Correctly Valued C 12.25% 11.00% Over Valued (ii) Strategy Stock Decision A Buy B Hold C Sell