Question

CAPM: The risk-free rate is 2%, Beta=1.6 and return to the market is 5%

Calculate excess return to the market

Calculate the required return on equity

What does a lower number mean vs a higher return on equity?

No spreadsheet, worked out

Answer 1

1:

excess return to the market= Market return - risk free rate

= 15%-2%=13%

2: Required return on equity = Rf+ beta*(Rm-Rf)

= 2%+1.6*(15%-2%)

= 22.8%

3: Lower required return on equity implies that the investors require a lesser return on the stock considering various factors especially low risk on the stock. Higher return implies that the stock carries high risk and so investors require a higher return on the stock.