Question

The expected rate of return on a Treasury Bill is 0.020, the expected rate of return on the Bud 5000 is 0.08 and the required rate of return of a stock is 0.10. What is the stocks beta?

Answer 1

The Capital asset pricing model (CAPM) as the name suggests, is a theory that explains how asset prices are formed in the market place.

The Capital Assets pricing model provides the framework for determining the equilibrium expected return for risky assets. It uses the result of capital market theory to derive the relationship between expected return and systematic risk of individual assets /securities and portfolios. Capital market theories, also referred to as asset pricing theories, deal with how asset prices are determined if investors behaved the way Markowitz's portfolio theory suggest.

E(r) = r(f) + Beta*[E(rm) - r(f)]

where, E(r) - Expected/Required Rate of return on Assets (0.10)

r(f) - Risk free rate of return (0.020)

Beta - systematic risk of Assets (?)

E(rm) - Expected return on market portfolio (0.08)

0.10 = 0.02 + Beta*[0.08-0.02)

0.10 - 0.02 = Beta*(0.06)

Beta = 0.08/0.06

= 1.33

So stocks(Bud 5000) beta = 1.33

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