Stock A has a beta of .9 and an expected return of 11 percent. Stock B
has a beta of 1.4 and an expected return of 22 percent. If the
risk-free rate is 6 percent and the market risk premium is 10 percent,
are these stocks correctly priced (over valued or undervalued)? (Hint:
CAPM problem) Please show your work and explain it in detail. If
possible please show how the problem can be entered into a financial
calculator. Thankyou!!!

Hello.

Here's the formula for the Capital Asset Pricing Model (CAPM):

Required Return = RF Rate + (Market Return - RF Rate) * Beta  
or
Required Return = RF Rate + (market risk premium) * Beta 

source: Investopedia.com Concepts: CAPM
http://www.investopedia.com/university/concepts/concepts8.asp

Applying the formula to the given figures:

Stock A
Required Return = RF Rate + (market risk premium) * Beta 
Required Return = .06 + (.10) * .9
Required Return = .15 (or 15%)

Here, the Expected Return (11%) is LESS than the Required Return
(15%), so Stock A is OVERVALUED (i.e., it's overpriced because the
expected return is below the level that CAPM indicates is required).


Stock B
Required Return = RF Rate + (market risk premium) * Beta 
Required Return = .06 + (.10) * 1.4
Required Return = .20

Here, the Expected Return (22%) is MORE than the Required Return
(20%), so Stock B is UNDERVALUED (i.e., it's underpriced because the
expected return is above the level that CAPM indicates is required).

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search strategy:
capm "rf rate" beta

I hope this helps.

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Clarification of Answer by juggler-ga on 11 Oct 2003 23:13 PDT

As for doing these problems on a calculator...

The math is very simple.

Stock A 
Required Return = RF Rate + (market risk premium) * Beta  
Required Return = .06 + (.10) * .9 

So, on your calculator, you'd simply:
enter .10 
then multiply it by 0.9
then add .06
hit the '=' key and...

Required Return = .15 (or 15%)