Question

Explain and solve, no excel

Example - CAPM Consider the betas for each of the assets given earlier. If the risk-free rate is 2.13% and the market risk premium (MRP) is 8.6%, what is the expected return for each? What is E(RM)?! o E(Rbac) = Rp + Blac(E(RM) - Rp) = 2.13 + 1.81 (8.6) = E(RKO) = Rp + Bko(E(Rm) – R) = 2.13 + 0.43 (8.6) = E(Rxom) = ? o E(Rintc) = ? o E(RM) = MRP + Rp =

Security C: 1.25

Security K: 0.95

Answer 1

According to CAPM model the required rate of return on a security is equal to

= risk free rate + Beta*(Market return- risk free rate)

Now market risk premium is equal to = (market return- risk free rate)

Now risk-free rate = 2.13%

Market risk premium (market return-risk free rate) = 8.6%

Security C beta = 1.25

So, security C required rate = 2.13 + 1.25*(8.6) = 12.88%

Security K beta = 0.95

So, security K required rate = 2.13 + 0.95*(8.6) = 10.30%

Now to calculate the market return, we use the formula

Market risk premium = (Market return- risk free rate)

8.6 = Market return – 2.13

Market return = 8.6 + 2.13 = 10.73

So, the expected return from the market is 10.73%.