Final answer:
Using the CAPM formula, the expected return for a stock with a 4% risk-free rate, a 1.4 beta, and a 7% market risk premium is 13.8%.
Step-by-step explanation:
The Capital Asset Pricing Model (CAPM) is a financial model that helps estimate the expected rate of return for an investment, considering its risk relative to the broader market. In this case, the student inquired about the expected rate of return for General Motors (GM) using the CAPM formula:
\[ \text{Expected Return} = \text{Risk-Free Rate} + \text{Beta} \times (\text{Market Risk Premium}) \]
Given the parameters:
- Risk-Free Rate = 4%
- Market Risk Premium = 7%
- Beta for General Motors = 1.4
We can substitute these values into the formula:
\[ \text{Expected Return} = 4\% + 1.4 \times 7\% = 4\% + 9.8\% = 13.8\% \]
Therefore, the expected rate of return for General Motors, according to the CAPM, is 13.8%. This figure reflects the risk associated with GM's stock compared to the risk-free rate and the overall market risk premium. It provides investors with an estimate of the return they might expect for holding GM stock, considering its risk profile in relation to the market.
It's important to note that the CAPM is a widely used model, but it has its assumptions and limitations, and actual market returns may vary from the estimates provided by the model.