CMA Final · Strategic Financial Management · Asset Pricing Theories
Stock Kaveri Ltd has an expected return of 16%, beta of 1.2. The risk-free rate is 7% and the market return is 14%. Using the Security Market Line, what is the alpha of the stock?
Alpha is +0.6%. The SML gives a required return of 7% plus 1.2 times the 7% market premium, which is 15.4%. The expected return of 16% exceeds this by 0.6%, so the stock plots above the line and is underpriced.
- A+1.6%Correct
- B+2.0%
- C-0.8%
- D+0.6%
Explanation
Required return = 7 + 1.2 x 7 = 15.4%. Alpha = expected - required = 16 - 15.4 = +0.6%. The +1.6% option is wrong because it uses 14.4% as required return, and -0.6 sign reversal is not offered; +0.6% is correct.
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