Question
In: Finance
This week’s 90-day T-bill rate is 2.8%, the average S&P return is 9.8%. Answer the following:...
This week’s 90-day T-bill rate is 2.8%, the average S&P return is 9.8%. Answer the following:
- What is the value of the intercept term and the slope?
- What is the stock’s risk premium?
- What is the market risk premium?
- Write the CAPM equation using the above data.
Solutions
Expert Solution
90-day T-Bill Rate = Risk-Free Rate = Rf = 2.8 % (T-Bill Rate is considered to be risk-free because T-Bills on account of being backed by the full faith and taxing power of the US Federal Government are considered to be default-free)
Average S&P Return = Rm = 9.8 % (S&P is considered to be the broad market as it encompasses an overwhelming majority of stocks available for investment)
The beta of the broader market is 1
Therefore, Required Return Equation using CAPM: R = Rf + Beta x (Rm - Rf) where R is the required return and plots against the y-axis and Beta is the systematic risk plotting against the x-axis.
As is observable, the y-axis intercept is equal to Rf and slope of the line = (R - Rf) / Beta
y-axis Intercept = Rf = 2.8 and slope = (R - 2.8) / Stock's Beta (slope of the stock and not the market). Market Slope = (9.8 - 2.8) / 1 = 7
Stock's Risk Premium = R - Rf = R - 2.8
Market Risk Premium = Rm - Rf = 9.8 -2 .8 = 7 %
CAPM Equation for Stock Return = R = Rf + Stock Beta x (Rm - Rf) =2.8 + Stock Beta x 7
jeff jeffy answered 1 year agoRelated Solutions
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