Question

Investors expect the market rate of return this year to be 16.50%. The expected rate of return on a stock with a beta of 1.5 is currently 24.75%. If the market return this year turns out to be 14.50%, how would you revise your expectation of the rate of return on the stock? (Do not round intermediate calculations. Round your answer to 1 decimal place.)

Answer 1

21.75%

Step-by-step explanation:

The computation of the expected rate of return is shown below:

According to the Capital Asset Pricing Model (CAPM)

Expected Rate of return = Risk Free Rate of Return + Beta ×(Market Rate of Return - Risk Free Rate of Return)

24.75% = Risk Free Rate of Return + 1.5 × (16.50% - Risk Free Rate of Return)

So,

Risk Free Rate of Return = 0%

Now If the market return this year turns out to be 14.50%

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

= 0% + 1.5 × (14.50% - 0%)

= 21.75%