Question

A stock has an required return of 9.75 percent, its beta is 0.65, and the risk-free rate is 4.25 percent. The expected return on the market must be

Answer 1

The expected return on the market, computed using the CAPM formula, is approximately 12.71% based on the given required return of 9.75%, stock beta of 0.65, and the risk-free rate of 4.25%.

Step-by-step explanation:

The student is asking about the calculation of the expected return on the market using the Capital Asset Pricing Model (CAPM). According to the CAPM, the expected return on a stock is equal to the risk-free rate plus the product of the stock's beta and the market risk premium (which is the expected market return minus the risk-free rate). We can use this information to solve for the missing expected market return.

The formula will look like this:

Required Return = Risk-free rate + Beta * (Expected Market Return - Risk-free rate)

We can rearrange the formula to solve for Expected Market Return:

Expected Market Return = (Required Return - Risk-free rate) / Beta + Risk-free rate

Plugging in the given numbers, we get:

Expected Market Return = (9.75% - 4.25%) / 0.65 + 4.25%

Expected Market Return = (5.5% / 0.65) + 4.25%

Expected Market Return ≈ 8.46% + 4.25%

Expected Market Return ≈ 12.71%