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The Treasury bill rate is 4%, and the expected return on the market portfolio is 14%
The Treasury bill rate is 4%, and the expected return on the market portfolio is 14%. According to the capital asset pricing model:
a. What is the risk premium on the market?
b. What is the required return on an investment with a beat of 1.4? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
c. If an investment with a beta of 0.7 offers an expected return of 9.0%, does it have a positive of negative NPV?
d. If the market expects a return of 12.0% from stock x, what is its beta?
Expert Solution
a). Computation of the risk premium on the market:-
Market risk premium = Expected market return - Risk free rate
= 14% - 4%
= 10%
b). Computation of the required return:-
Required return = Risk free rate + (Beta * Market risk premium)
= 4% + (1.4 * 10%)
= 4% + 14%
= 18.0%
c). Computation of the required return:-
Required return = Risk free rate + (Beta * Market risk premium)
= 4% + (0.7 * 10%)
= 4% + 7%
= 11%
Investment will have a negative NPV as the expected return (9%) is less than the required return.
d). Computation of the beta:-
Expected return = Risk free rate + (Beta * Market risk premium)
12% = 4% + (Beta * 10%)
Beta * 10% = 12% - 4%
Beta = 8% / 10%
= 0.8
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