IAI Actuarial Core Principles · Business Finance · Key principles of finance
Asset A of Mehta Industries has a risk-free rate of 6% available in the market, an expected market return of 12% and a beta of 1.5. Using CAPM, what is the required return on the share?
The required return is 15%. CAPM gives the risk-free rate of 6% plus beta of 1.5 times the market risk premium of 6% (12% minus 6%), which is 9%, totalling 15%.
- A15%Correct
- B18%
- C9%
- D12%
- 21%
Explanation
Required return = 6% + 1.5 × (12% − 6%) = 6% + 9% = 15%. The 18% option applies beta to the market return without deducting the risk-free rate (1.5 × 12%). The 21% option adds that beta-weighted market premium wrongly to 12%... in short, only 15% follows CAPM.
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