The Risk-Free Rate Is 4

question 21

Multiple Choice

The risk-free rate is 4.2 percent and the expected return on the market is 12.3 percent.Stock A has a beta of 1.2 and an expected return of 13.1 percent.Stock B has a beta of 0.75 and an expected return of 11.4 percent.Are these stocks correctly priced? Why or why not?

• A)No, Stock A is underpriced and Stock B is overpriced.
• B)No, Stock A is overpriced and Stock B is underpriced.
• C)No, Stock A is overpriced but Stock B is correctly priced.
• D)No, Stock A is underpriced but Stock B is correctly priced.
• E)Yes, both stocks are correctly priced.

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Definitions:

Decreasing Returns to Scale

A situation in which a firm experiences a less than proportional increase in output despite a proportional increase in all inputs, typically due to inefficiencies.

Increasing Opportunity Costs

The concept that as you produce more of one good, the opportunity cost of producing that next unit increases.

Scale Reduction

The process of downsizing the scope or size of operations, often in response to operational inefficiencies or declining profits.

Long-Run Average Total Cost

The average cost per unit of output incurred when all factors of production, including capital, are variable, considered over a sufficient period for all adjustments to be made.