Question

The Treasury bill rate is 3.9%, and the expected return on the market portfolio is 11.8%. Use the capital asset pricing model.

a. What is the risk premium on the market? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Risk premium             %

b. What is the required return on an investment with a beta of 1.4? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Required return             %

c. If an investment with a beta of .78 offers an expected return of 9.4%, does it have a positive NPV?

	Yes
	No

d. If the market expects a return of 10.4% from stock X, what is its beta? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Beta            

Answer 1

Given that the Treasury Bill rate = 3.9%

Risk-free Rate = R_f = 3.9% [Treasury bills are the risk-free assets]

Return on market portfolio = R_m = 11.8%

a. Risk premium on the market = R_m - R_f = 11.8% - 3.9% = 7.9%

Answer-> 7.9%

b. Beta of an investment = β_i = 1.4

CAPM Equation

R_i = R_f + β_i*(R_m - R_f)

Return on investment = R_i = 3.9% + 1.4*(11.8% - 3.9%) = 14.96%

Answer -> 14.96%

c. Required return is calculated using CAPM equation

Required return = 3.9%+ 0.78*(11.8% - 3.9%) = 10.062%

but the investment offers a return of 9.4% which is less than 10.062%. So, it does not have a positive NPV. Answer -> No

d. Market expects a return of 10.4% on stock X, E[R_x] = 10.4%

CAPM Equation

E[R_x] = R_f + β_x*(E[R_m] - R_f)

10.4% = 3.9% + β_x*(11.8% - 3.9%)

β_x = (10.4% - 3.9%)/7.9% = 0.82

Answer -> 0.82