Jerry Lee wishes to supplement his earnings by investing in the Malaysian stock He is considering the purchase of common stocks for long term investment. Market analysts have determined that the Proton stock has a 12% expected return and an expected beta of 1.1 whereas the Perodua stock has a 21% expected return with an expected beta of 1.5. Required: i)If the risk free rate is 6% and the market risk premium is 9%, determine which common stock is overvalued or undervalued by using the Capital Asset Pricing Model (C.A.P.M.). ii)Recommend to Jerry Lee which common stock he should select for long term investment.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Jerry Lee wishes to supplement his earnings by investing in the Malaysian stock He is considering the purchase of common stocks for long term investment. Market analysts have determined that the Proton stock has a 12% expected return and an expected beta of 1.1 whereas the Perodua stock has a 21% expected return with an expected beta of 1.5.
Required:
i)If the risk free rate is 6% and the market risk premium is 9%, determine which common stock is overvalued or undervalued by using the
ii)Recommend to Jerry Lee which common stock he should select for long term investment.
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