Question

Suppose the​ risk-free return is 3.7% and the market portfolio has an expected return of 11.2% and a standard deviation of 16%. Johnson​ & Johnson Corporation stock has a beta of 0.28. What is its expected​ return?

Answer 1

Solution :

As per Capital Asset Pricing Model, expected return of a stock is calculated using the following formula :

R_E = R_F + [ β * ( R_M - R_F ) ]

Where

R_E = Expected return of the stock ; R_F = Risk - free return   ; β = Beta of the stock ; R_M = Expected return of the market portfolio ;

As per the information given in the question we have

R_F = 3.7 %   ; R_M = 11.2 % ; β = 0.28   ;

Applying the above values in the formula we have

= 3.7 % + [ 0.28 * ( 11.2 % - 3.7 % ) ]

= 3.7 % + [ 0.28 * 7.5 % ]

= 3.7 % + 2.1 % = 5.8 %

Thus the expected return of the stock is 5.8 %