Question

1. What is beta? How it is used to calculate investors’ required rate of return?
2. Summarize the historical trade-off between risk and return.

Please show how to solve.

Answer 1

Beta is a measure of the volatility of a security in respect to the index and it will be also reflected as a systematic risk when, we will be calculating the Capital Asset pricing model.

Beta is used to calculate the investor's required rate of return by getting adopted to the Capital Asset pricing model which will be using the beta as a systematic risk and it will be provided with market risk premium product and then we will be adding the risk-free rate in order to arrive at the required rate of return of the investor.

Expected rate of return of investor= Risk-free rate+( Beta X Market risk premium)

Historical trade off between risk and return is related to theory that when there will be a higher risk, there will be a higher return and risk and return are always identical in nature according to the historical analysis and they will be always offering with the higher return for higher risk and lower return for the lower risk.

In this case, only when we are calculating the expected rate of return when risk is reflected through beta and when there will be a higher risk like 1.8, there will be a higher expected rate of return and when there will be a lower risk of lesser than 1, then it will offering with the expected rate of return which will be lower than the market rate of return.