Question

Use the Capital Asset Pricing Model to calculate the expected return of two stocks (X and Y) with the following characteristics: Beta for Stock X = 1.50: Beta for Stock Y = 0.75: Expected market Return = 9%, and 10-Year Treasury Note Rate = 3%. (Must show work to receive full credit)

Answer 1

Expected Return of Stock X Under CAPM Model
= Risk Free Rate + Beta of Stock X * (Market Return - Risk Free Rate)
= 3% + 1.50*(9% - 3%)
= 3% + 1.50 * 6%
= 3% + 9%
= 12%
Expected Return of Stock Y Under CAPM Model
= Risk Free Rate + Beta of Stock Y * (Market Return - Risk Free Rate)
= 3% + 0.75 * (9% - 3%)
= 3% + 0.75 * 6%
= 3% + 4.5%
= 7.5%
Expected Return of Stock X = 12%
Expected Return of Stock Y = 7.50%