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The risk-free rate of return is 3.9% and the market risk premium is 6.2%. What is the expected...

Question:

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:

Given -

  • 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

Or,

  • Required Rate of Return = 3.90 + 7.50

Or,

  • Required Rate of Return = 11.40%

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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