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A portfolio has a beta of 1.2. The risk free rate is 5 percent and the...

A portfolio has a beta of 1.2. The risk free rate is 5 percent and the market risk premium is 6 percent. What is the required rate of return?

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Answer #1

Information required:

Risk free rate= 5%

Market risk premium= 6%

Beta= 1.2

The question is solved using the capital asset pricing model.

The formula for calculating the required rate of return using the capital asset pricing model is given below:

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

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

B= Beta of the company

Rm – Rf= Market risk premium

Ke= 5% + 1.2*6%

     = 5% + 7.2%

     = 12.20%.

Therefore, the required rate of return is 12.2%.

In case of any query, kindly comment on the solution.

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