What would be the expected return on a stock given the following: the rate of re

Question

What would be the expected return on a stock given the following: the rate of return on 1 year CD's is 2%, the return on 90 day T-Bills is 4%, the return on 10 year T-Bonds is 7%, the Prime is 8%, the return on the S&P 500 is expected to be 12%, yiour stock is cionsidered to be twice as risky as the S&P 500 and the earth is 1 AU from the Sun. (AU = astronomical unit, roughly = to 93 million miles. While that has absolutely nothing to do with this problem, as a college student you should know tis stuff!)

Explanation / Answer

Risk free rate = return on 90 day T-Bills = 4%
Market Rate = Prime Rate = 8%
Using CAPM
Return on S&P = Risk free rate + Beta of S&P* (Market rate - Risk free rate)
=> 12 = 4+ Beta of S&P*(8-4)
Beta of S&P = 2

Beta of stock = 4
Expected return =  Risk free rate + Beta of stock* (Market rate - Risk free rate)
= 4+4*(8-4)
=20
Hence expected return on stock = 20%

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