Which of the following securities is underpriced in the market?
Solution
Correct Answer: Option A
The underpricing of securities in the market can be determined by comparing their expected return with their required rate of return. Let’s analyze the given options:
Security A: Expected return = 10%, Required rate of return = 18%
Security B: Expected return = 10%, Required rate of return = 12%
Security C: Expected return = 10%, Required rate of return = 10%
We can calculate the excess return (expected return minus required rate of return) for each security:
Security A: Excess return = 10% - 18% = -8%
Security B: Excess return = 10% - 12% = -2%
Security C: Excess return = 10% - 10% = 0%
Now, let’s compare the excess returns:
Security A has the highest negative excess return (-8%), indicating that it is underpriced relative to its required rate of return.
Security B has a smaller negative excess return (-2%), suggesting it is less underpriced.
Security C has no excess return (0%), meaning it is priced correctly.
Therefore, Security A is the most underpriced among the given options. Investors might find it attractive due to its potential for higher returns compared to its current pricing. Keep in mind that this analysis assumes efficient markets and no other relevant factors affecting pricing. Always consider additional information and conduct thorough research before making investment decisions.
Security A: Expected return = 10%, Required rate of return = 18%
Security B: Expected return = 10%, Required rate of return = 12%
Security C: Expected return = 10%, Required rate of return = 10%
We can calculate the excess return (expected return minus required rate of return) for each security:
Security A: Excess return = 10% - 18% = -8%
Security B: Excess return = 10% - 12% = -2%
Security C: Excess return = 10% - 10% = 0%
Now, let’s compare the excess returns:
Security A has the highest negative excess return (-8%), indicating that it is underpriced relative to its required rate of return.
Security B has a smaller negative excess return (-2%), suggesting it is less underpriced.
Security C has no excess return (0%), meaning it is priced correctly.
Therefore, Security A is the most underpriced among the given options. Investors might find it attractive due to its potential for higher returns compared to its current pricing. Keep in mind that this analysis assumes efficient markets and no other relevant factors affecting pricing. Always consider additional information and conduct thorough research before making investment decisions.
Practice More Questions on Our App!
Download our app for free and access thousands of MCQ questions with detailed solutions