Question

Suppose the risk-free return is 6.5% and the market portfolio has an expected return of 10.6% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.31. What is its expected return?

Answer 1

Answer and Explanation:

To calculate the expected return of Johnson & Johnson Corporation stock, we can use the Capital Asset Pricing Model (CAPM). The CAPM formula is:

Expected return = Risk-free rate + Beta * (Market return - Risk-free rate)

Given the following information:

- Risk-free return = 6.5%

- Market portfolio expected return = 10.6%

- Market portfolio standard deviation = 16%

- Johnson & Johnson Corporation stock beta = 0.31

Let's substitute these values into the CAPM formula:

Expected return = 6.5% + 0.31 * (10.6% - 6.5%)

Calculating the market risk premium:

Market risk premium = Market return - Risk-free rate

Market risk premium = 10.6% - 6.5%

Now, we can calculate the expected return:

Expected return = 6.5% + 0.31 * Market risk premium

Finally, substituting the value of the market risk premium:

Expected return = 6.5% + 0.31 * (10.6% - 6.5%)

Now, we can simplify the expression to calculate the expected return.