In: Finance
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?
CAPM equation:
Ri = Rf+B*(Rm-Rf)
or
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%
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?
Ri = 3% + 1.5 x 5% = 10.50%
Alpha generated = Market return - Calculated Ri = 15% - 10.50%
Alpha generated = 4.5%