Question

Suppose the rate of return on short-term government securities (perceived to be risk-free) is 2%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 1 is 16%.

According to the CAPM:

a. What is the expected rate of return on the market portfolio?

b. What would be the expected rate of return on a stock with β = 0?

Answer 1

expected return = risk free rate + beta * (market return - risk free rate)

a)

for a market portfolio, beta = 1

expected rate of return of market portfolio

= 2% + 1 * (16%-2%)

= 16%

b)

expected rate of return = 2% + 0 * (16% -2%)

= 2%