Question

Figure 8.11: Security market line Activity 8.14 Assume that the return on US Treasury bills is 3 per cent. the expected return on the market portfolio is 12 per cent. On the basis of the CAPM: 1. Draw a graph showing the relationship between the expected return and betal 2. What is the risk premium on the market? 3. What is the required return on a stock with a beta of 1.57 4. What is the beta of a stock if the market return is expected to be 12.5 per cent? *The solution to part of this activity can be found at the end of the subject guide in Appendix 1. Diversifiable risk and market risk

I already posted this question before but it hasn't been addressed, hopefully will get an answer this time

Answer 1

1)

Expected Return security Market tine Beta (B)

There is a direct relationship between expected return and beta .As the beta increases, the expected return increases.

2) Risk premium = Market return - risk free rate

   = 12% - 3%

= 9%

3) Expected return = Risk free rate + beta × (market risk premium)

= 3% + 1.5 × ( 9%)

= 3% + 13.5%

= 16.5%

4) Given: Expected return = 12.5%

Market premium = 9%

Risk free rate = 3%

Expected return = risk free rate + beta × market risk premium

12.5% = 3% + beta × 9%

12.5% - 3% = beta × 9%

Beta = 9.5% / 9%

= 1.056