Question

According to the CAPM, what is the market risk premium given an expected return on a security of 17.0%, a stock beta of 1.4, and a risk-free interest rate of 10%?

10.00%

14.00%

5.00%

7.70%

Answer 1

CAPM Approach

Formula:

Er= Rf + (Rm - Rf)

Given:

Er = Expected return on a security = 17%

Rf = Risk free rate of return = 10%

Rm=Return on market security = Not given

= Beta of the security = 1.4

(Rm - Rf) =Risk Premium = To find?

Solution:

Er= Rf + (Rm - Rf)

17%= 10% + 1.4 (Rm - Rf)

17% -10% = 1.4 (Rm - Rf)

7% =1.4 (Rm - Rf)

7%/1.4 = (Rm - Rf)

5% = (Rm - Rf) = Risk Premium

Hence option 3 is the correct answer i.e 5%