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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Investing in Stocks (NISM XXI-A)

A stock has a beta of 1.4. The risk-free rate is 7% and the expected market return is 12%. Using the CAPM, what is the required return on the stock?

The required return is 14%. Under CAPM it equals the risk-free rate of 7% plus beta of 1.4 times the market risk premium of 5%, which adds 7% to give 14%. Beta above one magnifies the market premium.

  1. A14.0%Correct
  2. B19.0%
  3. C17.6%
  4. D12.0%

Explanation

Market risk premium = 12 - 7 = 5%. Required return = 7 + 1.4 x 5 = 7 + 7 = 14%. The 19% option wrongly multiplies beta by the market return and adds the risk-free rate (7 + 1.4 x 12 = 23.8 is not it; 14 + 5 = 19 adds the premium twice). Checking: (14 - 7)/5 = 1.4.

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