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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

A stock has a beta of 0.8 under the CAPM with a risk-free rate of 2.0%. The stock's required return is 8.8%. The expected market return is closest to:

The expected market return is about 10.5%. Subtracting the 2.0% risk-free rate from the 8.8% required return leaves 6.8%, which divided by beta of 0.8 gives a market risk premium of 8.5%. Adding back the risk-free rate gives 10.5%.

  1. A8.5%
  2. B10.5%Correct
  3. C12.0%

Explanation

8.8% = 2.0% + 0.8 × (Rm − 2.0%). So 6.8% = 0.8 × premium, giving premium 8.5%. Rm = 2.0% + 8.5% = 10.5%. The 8.5% option is the premium, which is the error of not adding back the risk-free rate.

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