Problem:

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.

Required:

Question: Are these stocks correctly priced? Why or why not?

Select one:

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.

Note: Solve the problem and show all work.