FRM Part II · FRM Exam Part II · Capital Structure in Banks
A bank's cost of equity is estimated with CAPM. The risk-free rate is 3%, the market risk premium is 6%, and the bank's equity beta is 1.5. What is the cost of equity?
The cost of equity is 12%. CAPM gives the risk-free rate of 3% plus beta of 1.5 times the 6% market risk premium, which is 9%, totalling 12%.
- A9.0%
- B12.0%Correct
- C10.5%
- D13.5%
Explanation
Cost of equity = 3% + 1.5 x 6% = 3% + 9% = 12%. Choosing 9% omits the risk-free rate; 10.5% uses beta 1.25 incorrectly; 13.5% applies beta to the risk-free rate too.
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