A stock has a beta of 105 the expected return on the market

A stock has a beta of 1.05, the expected return on the market is 17 percent, and the risk-free rate is 5.95 percent. What must the expected return on this stock be? ? 18.25% o 1755% 16.67% ? 18.43% o 23.8%

Solution

According to CAPM Method expected return is:

E(R) = R_f + ß (R_m - R_f)

Where, E(R) = Expected return

R_f = Risk free rate = 5.95 % or 0.0595

ß = Beta = 1.05

R_m = Market risk premium = 17 % or 0.17

E(R) = 0.0595 + [1.05 x (0.17 – 0.0595)]

                      = 0.0595 + (1.05 x 0.1105)

                      = 0.0595 + 0.116025

                      = 0.175525 or 17.55 %

Hence option “17.55 %” is correct answer.