the risk-free rate is 3 % and you believe that the S&P 500's excess return will be 10 % over the next year. If you invest in a stock with a beta of 1.2 (and a standard deviation of 30 %), what is your best guess as to its expected excess return over the next year?

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Business

Frank Goodman

8 July, 03:25

the risk-free rate is 3 % and you believe that the S&P 500's excess return will be 10 % over the next year. If you invest in a stock with a beta of 1.2 (and a standard deviation of 30 %), what is your best guess as to its expected excess return over the next year?

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Emery · Answer 1

The expected excess return will be 11.4%

Explanation:

The S&P 500's excess return is the market return (rM). Using the CAPM model or the SML approach, we can calculate the required/expected rate of return on the stock we are investing in.

The expected rate of return is,

r = rRF + β * (rM - rRF)

Thus, return on the invested stock will be:

r = 0.03 + 1.2 * (0.1 - 0.03)

r = 0.114 or 11.4%