Question

A stock has a beta of 2.2, the risk-free rate is 6 percent, and the expected return on the market is 12 percent. Using the CAPM, what would you expect the required rate of return on this stock to be? What is the market risk premium?

Answer 1

Capital asset pricing is used to calculate Required rate of return

Required rate of return = Risk free rate of return + Beta( Market return - Risk free return)

Where,

Risk free rate of return= 0.06

Beta= 2.2

Market return= 0.12

Lets put all the values in the formula

Required rate of return = 0.06+2.2(0.12-0.06)

= 0.06 + 2.2( 0.06)

= 0.06 + 0.132

= 0.192

So the required rate of return is 19.2%

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Market risk premium = Marker return – risk free return

                                        = 12% - 6%

                                           = 6%

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