Question

The market risk premium is 10%, the risk-free rate is 1%, the value premium is 3%, and the small firm premium is 4%. A stock has a market beta of 1.5, a small firm beta of 0.5, and a value beta of 0.0. What is the expected return of the stock according to the CAPM and the FF3 models, respectively

Answer 1

CAPM = 18%

FF3 = 20%

Step-by-step explanation:

`Ke= r_f + \beta (r_m-r_f)`

risk free 0,03

premium market= (market rate - risk free) = 0,1

beta(non diversifiable risk) 1,5

`Ke= 0,03 + 1,5 (0,1)`

Ke 0,18000

Fama-French Model:

We add another factors to the CAMP rate:

one for the size and one for the value of the company

CAMP + 0.5 x 0.04 + 0

As the value beta is zero then, that factor will be zero.

FF3 = 0.18 + 0.02 + 0 = 0.20