Micro foods has a beta of 1.5. The market risk is 8.5%. The risk free rate is 5%. What is the...

Question:

Micro foods has a beta of 1.5. The market risk is 8.5%. The risk free rate is 5%. What is the expected return?

CAPM:

The CAPM developed by William F Sharpe, John Linter and Jan Mossin establishes a linear relationship between the required rate of return of a security and its beta. Beta, as we know is the non-diversifiable risk in a portfolio. A portfolio's standard deviation is a good indicator of its risk. Thus if adding a stock to a portfolio increases its standard deviation, the stock adds to the risk of the portfolio. This risk is the undiversified risk that can not be eliminated. Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio.

Answer and Explanation:

{eq}\beta= 1.5\ r_f=5% \ r_m=8.5% {/eq}

{eq}r_e= r_f+ \beta\times{(r_m-r_f)} {/eq}

{eq}r_e= 5+ 1.5\times{(8.5-5)} {/eq}= 5+5.25= 10.25%


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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