Question

Jocko was just told that the expected return for Echo stock was 20%, based on the CAPM. Assuming that the market return and the risk-free rate are 12% and 4%, respectively, what is the beta for Echo?

a) 1.0
b) 1.5
c) 2.0
d) 2.5

Answer 1

To calculate the beta for Echo stock with an expected return of 20%, when the market return is 12% and the risk-free rate is 4%, we use the CAPM formula. After substituting the values and solving for beta, we find that the beta is 2.0.

Step-by-step explanation:

The student has been told that the expected return for Echo stock is 20% according to the Capital Asset Pricing Model (CAPM), and they need to find the stock's beta given that the market return is 12% and the risk-free rate is 4%. To find the beta (\(\beta\)) of Echo stock, we use the CAPM formula: \(E(R_i) = R_f + \beta (R_m - R_f)\), where \(E(R_i)\) is the expected return on the asset, \(R_f\) is the risk-free rate, \(R_m\) is the expected market return, and \(\beta\) is a measure of the asset's volatility relative to the market.

Plugging in the given values, we get 20% = 4% + \(\beta\)(12% - 4%). Subtracting the risk-free rate from both sides gives us 16% = \(\beta\)(8%). After that, we divide both sides by 8% to solve for beta, yielding \(\beta\) = 2.0.

Therefore, the correct answer for the beta of Echo stock would be: c) 2.0.