The risk-free rate of return is 3.9% and the market risk premium is 6.2%. What is the expected rate of return on a stock with a beta of 1.21? Show work.
Capital Asset Pricing Model
The capital asset pricing model determines the required rate of return on an asset. It provides a relation between systematic risk and required returns. Based on the risk, a well diversified portfolio can be constructed.
Answer and Explanation:
- Risk Free Rate (Rf) = 3.9%
- Market Risk Premium (Rm - Rf ) = 6.2%
- Beta = 1.21
The formula for Capital Asset Pricing Model is as follows -
- Required Rate of Return = Rf + Beta * ( Rm - Rf )
With the values provided, we can find the required rate of return.
- Required Rate of Return = 3.9 + 1.21 * 6.2
- Required Rate of Return = 3.90 + 7.50
- Required Rate of Return = 11.40%
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from Financial Accounting: Help and ReviewChapter 15 / Lesson 6