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Stock A has a beta of 0.5, and investors expect it to return 5%. Stock B has a beta of 1.5, and investors expect it to return 13%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market.

Respuesta :

ijaz4308

Answer:

Market risk premium=8%

Expected market return=9%

Explanation:

Stock A

Expected return of A=Risk free rate+ Beta(Expected market return-Risk free rate)

In the given question:

Expected return of A=5%

Beta=0.5

5%=Risk free rate+0.50((Expected market return-Risk free rate)

Let say

Risk free rate=C

Expected market return=D

5%=C+0.50(D-A)

A=5%-0.50(D-A)

A=5%-0.50D+0.50C

0.50C+0.50D=5%--------(1)

Stock B

Expected return of B=Risk free rate+ Beta(Expected market return-Risk free rate)

In the given question:

Expected return of B=13%

Beta=1.5

13%=Risk free rate+1.50((Expected market return-Risk free rate)

Let say

Risk free rate=C

Expected market return=D

13%=C+1.50(D-C)

C=13%-1.50(D-C)

C=13%-1.50D+1.50C

1.50D-1.50C+C=13%

1.50D-0.50C=13%-----------(2)

Adding equation I AND 2

0.50C+0.50D+(1.50D-0.50C)=13%+5%

0.50C+0.50D+1.50D-0.50C=18%

2D=18%

D=18/2=9%

D=9%=Expected market return

Putting the value of D in equation 2 to find value of C

0.50C+0.50D=5%

0.50C+0.50*9%=5%

0.50C=0.5%

C=1%=Risk free rate

Market risk premium=Expected market return-Risk free rate

                                 =9%-1%

                                 =8%