Question

Examples of capital asset pricing model (CAPM), when it comes to the required rate of return.

Answer 1

The expected return of a stock can be calculated by the CAPM (CAPITAL ASSET PRICING MODEL) . The CAPM model formula is:

Re = Rf + beta * (Rm - Rf)

Where Re is the required rate of return,

Rf is the risk free rate, Rm is the return on the market.

For example, an investor is thinking of buying a share which is priced at $50 per share. The stock pays a dividend of $3, the stock has a beta compared to the market of 1.5. A beta of 1. 5 means that the stock is more risky than the market. The risk free rate is 5% and we can also expect the market rises by 9% per year.

So, the required return on the stock is:

Re = 5 + 1.5* (9% - 5%)

Re = 11%

So, the required return of this stock is 11%.