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Question:

An analyst determines that four stocks have the following characteristics:
If the risk-free rate is 4% and the expected return on the market is 10%, which of the following statements is least accurate?

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A Stock Y is undervalued.
explanation

Using the CAPM, the required rate of return for each stock is:
E(RX) = 4% + 1.0(10% - 4%) = 10.0%.
10.0% — 10.0% = 0.0% properly valued.
E(Ry) = 4% + 1.6(10% - 4%) = 13.6%.
16.0% - 13.6% = 2.4% undervalued.
E(RZ) = 4% + 2.0(10% - 4%) = 16.0%.
16.0% — 16.0% = 0.0% properly valued.

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