Stock A has a beta of .5, and investors expect it to return 7%. Stock B has a be
ID: 2735588 • Letter: S
Question
Stock A has a beta of .5, and investors expect it to return 7%. Stock B has a beta of 1.5, and investors expect it to return 16%. Use the CAPM to find the expected rate of return and the market risk premium on the market.
(Do not round intermediate calculations. Round your answers to 1 decimal place.)
Stock A has a beta of .5, and investors expect it to return 7%. Stock B has a beta of 1.5, and investors expect it to return 16%. Use the CAPM to find the expected rate of return and the market risk premium on the market.
(Do not round intermediate calculations. Round your answers to 1 decimal place.)
Expected rate of return % Market risk premium %Explanation / Answer
Required return = Rf + Market Risk Premium x Beta
Stock A
7% = Rf + Market Risk Premium*0.5
Market Risk Premium = (0.07 - Rf)/0.5 .......................(1)
Stock B
16% = Rf + Market Risk Premium*1.5
Market Risk Premium = (0.16 - Rf)/1.5 .......................(2)
From 1 and 2
(0.07 - Rf)/0.5 = (0.16 - Rf)/1.5
On solving the equation we get,
Rf(Risk free rate) = 2.5%
Market Risk Premium = (0.16 - 0.025)/1.5 = 0.09 or 9%
Expected Return:
Stock A = 7%
Stock B = 16%
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