Answer to Question #272479 in Management for Raj

Question

You are a financial advisor at XYZ Stock Broking firm. Calculate the return as per CAPM for following company’s stock, identify whether the stocks are undervalued, overvalued or correctly priced and advise accordingly. Returns of T- Bill is 7%. (10 Marks) Stock Expected Return Beta Tata 21% 1.7 Adani Power 16% 1.4 Ranbaxy 23% 1.1 PNB 19% 1.2 Sensex 18%

Answer 1

You are a financial advisor at XYZ Stock Broking firm. Calculate the return as per CAPM for following company’s stock, identify whether the stocks are undervalued, overvalued or correctly priced and advise accordingly. Returns of T- Bill is 7%. (10 Marks) Stock Expected Return Beta Tata 21% 1.7 Adani Power 16% 1.4 Ranbaxy 23% 1.1 PNB 19% 1.2 Sensex 18%

 

Answer:

Mathematically, the CAPM formula is the risk-free <span style="font-size:13.5pt;font-family:&quot;Arial&quot;,&quot;sans-serif&quot;; color:#2C40D0;letter-spacing:.05pt;background:white">rate of return</span> added to the <span style="font-size:13.5pt;font-family:&quot;Arial&quot;,&quot;sans-serif&quot;;color:#2C40D0; letter-spacing:.05pt;background:white">beta</span> of the security or portfolio multiplied by the expected market return minus the risk-free rate of return:

 Expected return = Risk Free Rate + [Beta x Market Return Premium]

A security with a beta higher than 1.0 carries greater systematic risk and <span style="font-size:13.5pt;font-family:&quot;Arial&quot;,&quot;sans-serif&quot;;color:#2C40D0; letter-spacing:.05pt;background:white">volatility</span> than the overall market, and a security with a beta less than 1.0, has less systematic risk and volatility than the market.In this case the company is at risk because its beta is higher than 1.0.

Priority will be Ranbaxi 23% 1.1, then Tata 21% 1.7, then PNB 19% 1.2 and the least priority will be Adani Power 16% 1.4.