The Standard Deviation of stock returns for Stock A is 60% and The standard Deviation of...

The Standard Deviation of stock returns for Stock A is 60% and The standard Deviation of market returns is 30% so If the statistical correlation between Stock A and the overall market is 0.6, then the beta for stock A is: 60%/30% x 0.6= 1.2

What is the expected risk premium for investors with this beta value compared to the market average for returns on investment?

Expert Solution

Thee CAPM (capital asset pricing model) is a universally acknowledged and used model used for the calculation of expected return of assets (more for stocks). It provides us the below formula for calculating the expected return on investment as a function of market return and beta which is further a factor which is calculated based on the standard deviation of the stock as a function of the standard deviation of the market (considered as a proxy of the risk in the stock) and the correction between the stock and market. It thus gives a relation between the systematic risk involved in the market and the expected return from any stock.

The formula for calculating expected return on any stock can be written as:

E(R)= Rf + beta×Risk premium

= Rf + beta × (Rm-Rf)

Thus Risk premium = ( E(R)-Rf )/beta

=Incremental return over market averages /beta

Here beta = 1.2 (given in question as a function of the standard deviation of stock & market and also considering the correlation between stock and market)

Here as beta is more than 1 i.e 1.2, the denominator is more than 1 making the Risk premium to be lesser than market.

jeff jeffy answered 3 weeks ago

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