Compute the expected return of Firm A, which has a 1.2 beta. The risk-free rate is...

Compute the expected return of Firm A, which has a 1.2 beta. The risk-free rate is 3.5% and the market portfolio has an expected return of 16%. Why the expected return is greater than the market return?

Clearly show which EQUATIONS could be used to solve the problem mathematically
Indicating the detailed steps on how to use FINANCIAL CALCULATOR or Equations from the Textbook to solve the problems.

Expert Solution

As per CAPM, Expected Return = Risk free Return + beta*(Market Return - Risk free Return)

Expected Return on A = 3.5% + 1.2*(16%-3.5%)

= 18.5%

Beta is a measure of risk. Beta of market is 1.

Since A has higher beta, it is riskier than the market. With higher risk, comes higher returns. Hence, expected return on A is higher than the market return.

jeff jeffy answered 2 years ago

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