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18 March, 08:31

Investors expect the market rate of return this year to be 16.50%. The expected rate of return on a stock with a beta of 1.5 is currently 24.75%. If the market return this year turns out to be 14.50%, how would you revise your expectation of the rate of return on the stock? (Do not round intermediate calculations. Round your answer to 1 decimal place.)

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  1. 18 March, 10:23
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    21.75%

    Explanation:

    The computation of the expected rate of return is shown below:

    According to the Capital Asset Pricing Model (CAPM)

    Expected Rate of return = Risk Free Rate of Return + Beta * (Market Rate of Return - Risk Free Rate of Return)

    24.75% = Risk Free Rate of Return + 1.5 * (16.50% - Risk Free Rate of Return)

    So,

    Risk Free Rate of Return = 0%

    Now If the market return this year turns out to be 14.50%

    Expected Rate of Return = Risk Free Rate of Return + Beta * (Market Rate of Return - Risk Free Rate of Return)

    = 0% + 1.5 * (14.50% - 0%)

    = 21.75%
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