Question

Consider the following year-end prices of a hypothetical market index.
(1) Calculate the annual returns of the market index, and use the average annual return as the expected return of the market index.
(2) Assume the risk-free rate is 0.75%, and use the above market index as the market portfolio. What is the expected return of asset A with a beta of 0.8 using CAPM model?
	market index
2004	100
2005	110
2006	104.5
2007	106.59
2008	106.59
2009	110.85
2010	108.63

Answer 1

Expected Market Return = Rm = 1.5 %, Risk-Free Rate = Rf = 0.75 % and Beta of Asset A = Ba = 0.8

Using CAPM, Expected Return on Asset A = Rf + Ba x (Rm - Rf) = 0.75 + 0.8 x (1.5-0.75) = 1.35 %