Question

The risk-free rate is 4.2 percent and the market expected return is 11.1 percent. What is the expected return of a stock that has a beta of 1.27?

A) 19.82%
B) 12.96%
C) 18.30%
D) 11.52%
E) 15.63%

Answer 1

Using the CAPM formula, the expected return of a stock with a beta of 1.27, given a risk-free rate of 4.2 percent and a market expected return of 11.1 percent, is calculated to be 12.96 percent. Option B is correct.

Step-by-step explanation:

To calculate the expected return of a stock using the Capital Asset Pricing Model (CAPM), we use the formula:

Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

In this case, the risk-free rate is 4.2 percent, the market expected return is 11.1 percent, and the stock's beta is 1.27. Plugging the values into the formula, we get:

Expected Return = 4.2% + 1.27 * (11.1% - 4.2%)

Expected Return = 4.2% + 1.27 * 6.9%

Expected Return = 4.2% + 8.763%

Expected Return = 12.963%, or when rounded, 12.96%%

Therefore, the expected return of the stock is Option B) 12.96%%.

To calculate the expected return of a stock, we can use the Capital Asset Pricing Model (CAPM) formula:

Expected Return = Risk-Free Rate + Beta * (Market Expected Return - Risk-Free Rate)

In this case, the risk-free rate is 4.2 percent, the market expected return is 11.1 percent, and the beta is 1.27.

Plugging in the values into the formula:

Expected Return = 4.2% + 1.27 * (11.1% - 4.2%) = 4.2% + 1.27 * 6.9% = 4.2% + 8.763% = 12.963%

Therefore, the expected return of the stock is 12.963%, which is approximately 12.96% (option B).