Question

Suppose the beta of this value based company is 0.85, the risk-free rate is 2 percent, and the expected market rate of return is 10 percent. Calculate the expected rate of return. The answer is closest to:

o 10.5 percent
o 13.1 percent
o 6.5 percent
o 9.0 percent

Answer 1

The expected rate of return is 8.8%. The closest option to this value is 9.0 percent. Expected return calculations are a key piece of both business operations and financial theory, including in the well-known models of the modern portfolio theory (MPT) or the Black-Scholes options pricing model.

Step-by-step explanation:

The expected rate of return is calculated using the formula:

Expected rate of return = Risk-free rate + Beta × (Expected market rate of return - Risk-free rate)

Substituting the given values, we have:

Expected rate of return = 2% + 0.85 × (10% - 2%)

Expected rate of return = 2% + 0.85 × 8%

Expected rate of return = 2% + 6.8%

Expected rate of return = 8.8%

The closest option to the calculated expected rate of return is 9.0 percent.

The expected return is the amount of profit or loss an investor can anticipate receiving on an investment. An expected return is calculated by multiplying potential outcomes by the odds of them occurring and then totaling these results. Expected returns cannot be guaranteed.