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CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II

The risk-free rate is 3%, the expected market return is 9%, and a stock has a beta of 1.25. Using the CAPM, the stock's required return is closest to:

The required return is about 10.5%. The market risk premium is 6% (9% minus 3%), multiplied by a beta of 1.25 gives 7.5%, which is added to the 3% risk-free rate. Using the market return alone would ignore the stock's higher systematic risk.

  1. A9.0%
  2. B10.5%Correct
  3. C12.0%

Explanation

Required return = 3% + 1.25 × (9% − 3%) = 3% + 7.5% = 10.5%. Choosing 9.0% ignores beta (market return), and 12.0% wrongly applies beta to the full market return (1.25 × 9% + 0.75%... or adds 1.25×6 to 4.5), not the premium.

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