Question

Suppose the rate of return on short-term government securities (perceived to be risk-free) is about 7%. Suppose also that the expected rate of return required by the market for a portfolio with a beta of 1 is 13%. According to the capital asset pricing model:

Answer 1

Answer: ER(P) = Rf + β(Rm - Rf)

ER(P) = 7 + 1(13-7)

ER(P) = 7 + 6

ER(P) = 13%

Explanation: According to capital asset pricing model, the expected return on a portfolio is a function of risk free rate and market risk premium. Market risk premium is the product of Beta(market risk) and risk premium ie β(Rm-Rf)