Assume that the CAPM holds. One stock has an expected return of 8% and a beta of 0.5. Another stock has an expected return of 13% and a beta of 1.5. Part 1 IB - Attempt 1/10 for 10 pts. What is the expected return on the market?

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Business

Shaun Gamble

23 July, 22:34

Assume that the CAPM holds. One stock has an expected return of 8% and a beta of 0.5. Another stock has an expected return of 13% and a beta of 1.5. Part 1 IB - Attempt 1/10 for 10 pts. What is the expected return on the market?

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Answers (1)

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Stephanie Walter · Answer 1

10.5%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

For one stock

8% = Risk-free rate of return + 0.5 * (Market rate of return - Risk-free rate of return)

8% = Risk-free rate of return + 0.5 * Market rate of return - 0.5 * Risk-free rate of return

8% = 0.5 * Risk-free rate of return + 0.5 * Market rate of return

8% : 0.5 = Risk-free rate of return + Market rate of return

So, Risk-free rate of return + Market rate of return = 16

Risk-free rate of return = 16 - Market rate of return - 1

For another stock

13% = Risk-free rate of return + 1.5 * (Market rate of return - Risk-free rate of return)

13% = Risk-free rate of return + 1.5 * Market rate of return - 1.5 * Risk-free rate of return

13% = - 0.5 * Risk-free rate of return + 1.5 * Market rate of return - 2

Now put these equations together

13% = - 0.5 * (16 - Market rate of return) + 1.5 * Market rate of return

13% = - 8 + 0.5 * Market rate of return + 1.5 * Market rate of return

So, Market rate of return would be

= 21 : 2

= 10.5%