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CMA Final · Strategic Financial Management · Asset Pricing Theories

A stock has beta 1.25 and an expected return of 15%. The risk-free rate is 7%. If the stock is fairly priced under the CAPM, what is the expected return on the market portfolio?

The market return is 13.4%. The stock's excess return over the risk-free rate is 15% − 7% = 8%. Dividing by beta of 1.25 gives a market risk premium of 6.4%. Adding the 7% risk-free rate gives a market return of 13.4%.

  1. A13.4%Correct
  2. B17.0%
  3. C12.0%
  4. D8.0%

Explanation

15 = 7 + 1.25 × (Rm − 7), so Rm − 7 = 8/1.25 = 6.4 and Rm = 13.4%. Giving 17% multiplies the 8% excess return by beta instead of dividing. Giving 12% divides the whole return by beta.

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