Question

What comes closest to ABC Inc’s beta if its expected return is 15%, the expected return on the market is 8%, and the riskless rate is 2%?

a. 1.9
b. 1.63
c. 2.2
d. 2.5

Answer 1

Beta = 2.167 rounded off to 2.2

Option c is the correct answer

Step-by-step explanation:

Using the CAPM, we can calculate the required rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

rRF is the risk free rate

rM is the market return

As we already know the risk free rate, the return on market and the expected return on stock, plugging in these values in the formula we can calculate the beta of the stock.

0.15 = 0.02 + Beta * (0.08 - 0.02)

0.15 - 0.02 = Beta * 0.06

0.13 / 0.06 = Beta

Beta = 2.167 rounded off to 2.2