1. The risk free rate is 2%, the risk premium for the market is 5%, and...

1. The risk free rate is 2%, the risk premium for the market is 5%, and a stock has an expected return of 10.5%. What is the firm’s beta?

2. A firm has a beta of 1.3 and the risk premium for the market is 6%. If the firms expected return is 11%, what is the risk free rate?

3. A firm with a beta of 1.5 has a market return of 15% when the risk free rate is 3% and the risk premium for the market is 5%. What conclusions can you draw regarding the alpha generated from this investment?

Solutions

Expert Solution

CAPM equation:

Ri = Rf+B*(Rm-Rf)

Ri = Rf + B x Market risk premium

Ri = Expected return on stock or security

Rm = Market Return

Beta of firm = B

Rf = Risk free rate

1. The risk free rate is 2%, the risk premium for the market is 5%, and a stock has an expected return of 10.5%. What is the firm’s beta?

10.5% = 2% + B x 5%

B = (10.5% - 2%)/5%

Beta of firm = 1.70

2. A firm has a beta of 1.3 and the risk premium for the market is 6%. If the firms expected return is 11%, what is the risk free rate?

11% = Rf + 1.3 x 6%

Rf = 11% - 1.3 x 6%

Rf or Risk free rate = 3.20%

Ri = 3% + 1.5 x 5% = 10.50%

Alpha generated = Market return - Calculated Ri = 15% - 10.50%

Alpha generated = 4.5%

jeff jeffy answered 1 year ago

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