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25 February, 21:40

We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, - 0.2. a. If the interest rate on Treasury bills is 6% and the expected return on the market portfolio is 16%, what is the expected return on the shares of the law firm according to the CAPM?

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Answers (1)
  1. 25 February, 22:43
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    4%

    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)

    = 6% - 0.2 * (16% - 6%)

    = 6% - 0.2 * 10%

    = 6% - 2%

    = 4%

    The (Market rate of return - Risk-free rate of return) is also known as market risk premium
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