Question

cpnsider capm the risk free rate is ^5 and the expected return on the market is 18% what is the expected return on a stock with a beta of 1.3

Answer 1

Expected return = 21.9 %

Step-by-step explanation:

The capital asset pricing model is a risk-based model. Here, the return on equity is dependent on the level of reaction of the the equity to changes in the return on a market portfolio. These changes are captured as systematic risk. The magnitude by which a stock is affected by systematic risk is measured by beta.

Under CAPM, Ke= Rf + β(Rm-Rf)

Rf-risk-free rate (long-term i.e 10 year treasury bill rate), β= Beta, Rm= Return on market., Ke- Return on equity (cost of equity)

This model can be used to work out the cost of equity as follows:

Ke= Rf + β (Rm-Rf)

Rf- 5%, β= 1.3, Rm- 18, E(r)- ?

Ke = 5% + 1.3×(18-5)%=21.9 %

Ke = 21.9 %

Expected return = 21.9 %