NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Modern Portfolio Theory
A stock has a beta of 1.2. The risk-free rate is 6% and the expected market return is 11%. Using CAPM, what is the required return on the stock?
The required return is 12%. CAPM gives risk-free rate plus beta times the market risk premium: 6% plus 1.2 times 5%, which equals 6% plus 6%. Using the full market return instead of the premium produces the incorrect higher values.
- A12.0%Correct
- B11.0%
- C13.2%
- D17.0%
Explanation
Required return = Rf + beta x (Rm - Rf) = 6 + 1.2 x (11 - 6) = 6 + 6 = 12%. The 17% option wrongly takes 1.2 x 11 + 6 - ... i.e. it adds beta x market return to the risk-free rate (6 + 13.2 = 19.2 is not it; 6+11 = 17 ignores beta). 13.2% is beta x market return without the risk-free adjustment.
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