Question

Assume the risk-free rate is 3% and the market return is 8%. According to the Capital Asset Pricing Model (CAPM), what is the return of a stock with beta of 1.4?

15.8%

8.0%

11.0%

7.8%

None of the above.

Answer 1

Information provided:

Risk free rate= 3%

Market return= 8%

Beta= 1.4

The expected return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke=Rf+$\beta$[E(Rm)-Rf]

Where:

Rf=risk-free rate of return

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

$\beta$= Stock’s beta

Ke= 3% + 1.4*(8% - 3%)

     = 3% + 7%

     = 10%.

Hence, the answer is option d.

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