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According to the CAPM, the required rate of return on a stock can be estimated using only beta and the risk-free rate.

A) True
B) False

1 Answer

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Final answer:

The statement is False; the CAPM formula uses not only beta and the risk-free rate but also includes the equity market premium to estimate the required rate of return on a stock.

Step-by-step explanation:

The statement that the required rate of return on a stock can be estimated using only beta and the risk-free rate according to the Capital Asset Pricing Model (CAPM) is False. The CAPM formula actually includes three components to estimate the expected returns of a security: the risk-free rate, the beta of the investment (which measures its volatility in comparison to the market), and the equity market premium (which is the expected market return minus the risk-free rate). The formula is as follows: Required Rate of Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). This model reflects the understanding that stocks have an average return higher than bonds, and bonds have an average return higher than a savings account due to varying levels of risk and potential return. A high-risk investment typically offers the potential for a high return to incentivize investors to take on the increased uncertainty.

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