Assume that the risk-free rate is 2.5% and the required return on the market is 8%. What is the...

Question:

Assume that the risk-free rate is 2.5% and the required return on the market is 8%.

What is the required rate of return on a stock with a beta of 1.9? Round your answer to two decimal places.

Capital Asset Pricing Model:

The capital asset pricing model gives the relation between risk and the required rate of return for a stock. The risk here is the systematic risk that cannot be diversified. Therefore, higher the systematic risk for a stock, higher is the beta and so is the required rate of return by investors.

Answer and Explanation:

.

Given -

  • Risk Free Rate (Rf) = 2.5%
  • Required Return on Market (Rm) = 8%
  • Beta (B) = 1.9

The formula to calculate the required return on stock using the CAPM is as follows -

  • Required Return on Stock = {eq}Rf + B * ( Rm - Rf ) {/eq}
  • Required Return on Stock = {eq}2.5 + 1.9 * ( 8 - 2.5 ) {/eq}
  • Required Return on Stock = {eq}12.95 {/eq}

Learn more about this topic:

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Capital Asset Pricing Model (CAPM): Definition, Formula, Advantages & Example

from Financial Accounting: Help and Review

Chapter 15 / Lesson 6
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