CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II
An analyst plots a stock on the security market line (SML) chart. The stock's expected return lies above the SML at its beta. The stock is most likely:
The stock is most likely undervalued with a positive alpha. Its expected return exceeds the return required by CAPM for its beta, so it plots above the SML. Investors would buy it, pushing the price up and the expected return down toward the line.
- Afairly priced, with an alpha of zero
- Boverpriced, with a negative alpha
- Cundervalued, with a positive alphaCorrect
Explanation
A point above the SML offers more expected return than required for its beta, so alpha is positive. Buying pressure should raise its price until the expected return falls back onto the line. A negative alpha would plot below the line.
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