In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater than the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.

Here, the holding period (or expected) return is calculated as: (ending price – beginning price + any cash flows / dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate − risk-free rate).

• For CS Industries: ER = (30 – 25 + 1) / 25 = 24%, RR = 6 + 1.2 × (15 − 6) = 16.8%. Stock is underpriced - purchase.
• For MG Consolidated: ER = (55 – 50 + 1) / 50 = 12%, RR = 6 + 0.80 × (15 − 6) = 13.2%. Stock is overpriced - do not purchase.