Question

suppose you are studying the risk-expected return tradeoff for two stocks. one stock, jefferson co has a beta of 1.8 and expected return of 13.0%, while the other stock marion inc, has a beta of 0.7 and expected return of 9.5%. according to the capm, what must be the market risk premium? answer in decimal format rounded to four decimal places. for example, if you answer is 8.25%, enter .0825.

Answer 1

The market risk premium can be calculated using the Capital Asset Pricing Model (CAPM). In this case, we need to find the market risk premium based on the given betas and expected returns of two stocks. By calculating the beta of the market and using the difference between the expected return and the risk-free rate of return, we can determine the market risk premium.

Step-by-step explanation:

According to the Capital Asset Pricing Model (CAPM), the expected return on an investment is determined by multiplying the beta of the investment with the market risk premium. The market risk premium is the difference between the expected return on the market and the risk-free rate of return. In this case, we need to calculate the market risk premium.

First, we need to find the risk-free rate of return. Let's assume it is 5%.

The expected return on Jefferson Co is 13.0% and Marion Inc is 9.5%. Now, we can calculate the beta of the market by using the formula:

Beta of the market = Beta of Jefferson Co * (Expected return of Jefferson Co - Risk-free rate of return) / (Expected return of Jefferson Co - Expected return of Marion Inc)

Substituting the given values:

Beta of the market = 1.8 * (0.13 - 0.05) / (0.13 - 0.095) = 1.8 * 0.08 / 0.035 = 4.114285714

Finally, we can calculate the market risk premium by multiplying the beta of the market with the difference between the expected return of Jefferson Co and the risk-free rate of return:

Market risk premium = Beta of the market * (Expected return of Jefferson Co - Risk-free rate of return) = 4.114285714 * (0.13 - 0.05) = 4.114285714 * 0.08 = 0.3291428571