Question

The risk premium for exposure to aluminum commodity prices is 4%, and the firm has a beta relative to aluminum commodity prices of .6. The risk premium for exposure

to GDP changes is 6%, and the firm has a beta relative to GDP of 1.2. If the risk-free rate is 4%, what is the expected return on this stock?

A.
14.4 percent

B.
10.0 percent

C.
13.6 percent

D.
11.5 percent Please show work

Answer 1

C. 13.6 percent

Step-by-step explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta × risk-free rate of return + Beta × market risk premium

= 4% + 0.6 × 4% + 1.2 × 6%

= 4% + 2.4% + 7.2%

= 13.6%

The (Market rate of return - Risk-free rate of return) is also known as market risk premium