Part 1 of 2:

According to CAPM, Stock A is undervalued and has a positive alpha.

Question

Part 1 of 2:

According to CAPM, Stock A is undervalued and has a positive alpha.

BlackTom AI · Accepted Answer

Question restatement: The prompt asks us to consider CAPM concepts for Stock A, stating that it is undervalued and has a positive alpha, and this is presented as a part of a two-part item with no answer options provided in this input.

First, note there are no answer choices to evaluate. Without options to compare against, we cannot select or rule out a correct statement. Instead, we can reason about what the claims imply within CAPM and how they interact, which is useful context for interpreting such statements in a broader question.

Exploring the CAPM-related ideas mentioned:
- Alpha in CAPM terms: Alpha measures the abnormal return of a security relative to what CAPM predicts given its beta. A positive alpha suggests the stock earns more than the CAPM would predict based on its systematic risk, implying either mispricing or that other factors are delivering excess returns beyond market risk. In a well-functioning CAPM world, persistent positive alpha would be evidence against the model's completeness or would indicate timing or estimation issues.
- Undervalued in relation to CAPM: CAPM itself does not directly label a stock as undervalued or overvalued in price terms. Undervalued typically means the current price is below the intrinsic value or fundamentals-based price. In practice, traders might interpret a stock as undervalued if its price today implies a higher expected return than required by its risk (beta) as per CAPM, potentially aligning with a positive alpha scenario if the market has mispriced the security.

With these ideas in mind, consider how the two claims interact:
- If a stock truly has a positive alpha, its observed return exceeds the CAPM-predicted return for its beta. This could be evidence of mispricing (undervalued price) or of other return drivers not captured by CAPM.
- Saying Stock A is undervalued might be consistent with a positive alpha, but it is not a guarantee. Undervalued pricing would imply room for price appreciation as the market corrects, which could accompany a positive alpha if investors discover the mispricing.

Potential pitfalls or misconceptions to watch for:
- Alpha being positive does not prove the stock is undervalued; it only shows outperformance relative to CAPM. The stock could still be fairly valued or overvalued if the alpha is due to estimation error, risk factors not captured by CAPM, or short-term anomalies that may not persist.
- CAPM assumes a single factor—market beta—driving returns. Real-world deviations (e.g., size, value, momentum) may create positive alpha even if the stock is not truly undervalued under a multi-factor framework.

In summary, within CAPM reasoning, a positive alpha suggests returns above what CAPM predicts for the stock’s beta, which could be consistent with mispricing and potentially with undervalued pricing, but does not by itself prove undervaluation. Without answer choices to assess, the key takeaway is understanding how positive alpha signals excess return relative to CAPM and how undervaluation relates to price versus intrinsic value, which CAPM does not directly define.

COMM_V 298 101 102 103 2025W1 Class 16 Practice Quiz

Part 1 of 2: According to CAPM, Stock A is undervalued and has a positive alpha.

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