The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should
A. buy CAT because it is overpriced.
B. sell short CAT because it is overpriced.
C. sell short CAT because it is underpriced.
D. buy CAT because it is underpriced.
E. None of the options, as CAT is fairly priced.
B. sell short CAT because it is overpriced.
10% < 4% + 1.0(11% – 4%) = 11.0%; therefore, CAT is overpriced and should be shorted.
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