Question

(Capital asset pricing model) The expected return for the general market is 13.9%, and the risk premium in the market is 7.0%. Tasaco, LBM, and Exxos have betas of 0.834, 0.649, and 0.522, respectivily. What are the corresponding required rates of return for the three securities?

Answer 1

As per Capital Asset Pricing Model:

Required rate of return = Rf + ß(Market risk premium)

Where, Rf = Expected Return or Risk free return

ß = Risk factor or beta

• Corresponding required rates of return for the 3 securities:

1. Tasaco: Required rate of return = 13.9 + 0.834(7) = 19.738%
2. LBM: Required rate of return = 13.9 + 0.649(7) = 18.443%
3. Exxos: Required rate of return = 13.9 + 0.552(7) = 17.554%

• Conclusion: Beta of Tasaco indicates that higher the risk, higher the return. Tasaco has the highest risk factor of 0.834 & has the higher return of 19.738% among the 3 securities.
• However, Exxos has the lowest risk factor and lower rate of return among the 3 securities.