Question

The beta on Stock A equals 0.75, and the expected return equals 8.625%. The risk free rate equals 3%. Calculate the expected return on the market.

(Enter percentages as decimals and round to 4 decimals)

Answer 1

Solution:           

As per Capital Asset Pricing model the Expected return on stock is calculated using the following formula :

E(R) = R_F + [ β * ( R_M - R_F ) ]

Where

E(R) = Expected Return on stock ; R_F = Risk free rate   ; β = Beta of the stock ;   R_M = Expected Return on the market

Calculation of Expected Return on the market

As per the information given in the question we have

R_F = 3 %   ; β = 0.75 ;    E(R ) = 8.625 % ; R_M = To find  

Applying the above values in the formula we have

8.625 % = 3 % + [ 0.75 * (R_M - 3 % ) ]

8.625 % - 3 % = [ 0.75 * (R_M - 3 % ) ]

5.625 % = 0.75 * (R_M - 3 % )

5.625 % / 0.75 = ( R_M - 3 % )

7.50 % = ( R_M - 3 % )

R_M = 7.50 % + 3 %

R_M = 10.50 %

R_M = 0.1050 ( When percentages are written as decimals rounded off to four decimal places )

Thus the Expected Return on the market is = 10.5000 % = 0.1050