Question

1. Using the CAPM, if a stock had a Beta of 1.35, the risk free rate was 4% and the Market rate was 7.5%, what would the expected rate of return be?

2. What is the beta for the following portfolio?

Stock A is 60% with a beta of 1.25

Stock B is 30% with a beta of 0.9

Stock C I s10% with a beta of -.25

3. In the example above, which Stock would have more volatility relative to the market?

1. Stock A

2. Stock B

3. Stock C

Answer 1

1.The expected return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke= Rf+b[E(Rm)-Rf]

Where:

Rf= risk-free rate of return

Rm= expected rate of return on the market.

Rm-Rf= Market risk premium

b= Stock’s beta

Ke= 4% + 1.35*(7.5% - 4%)

   = 4% + 1.35*3.50%

= 4% + 4.7250%

= 8.7250% 8.73%.

Beta of the portfolio= 0.60*1.25 + 0.30*0.90 + 0.10*-0.25

= 0.75 + 0.27 - 0.0250

= 0.9950.

In the above example, stock A has more volatility relative to the market since it has the highest beta.

Hence, the answer is option a.