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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 1.4. Using the capital asset pricing model, the stock's required return is closest to:

The required return is about 11.4%. Under CAPM it equals the risk-free rate of 3% plus beta of 1.4 times the 6% market risk premium, which is 8.4%. Forgetting to add the risk-free rate gives 8.4%, while applying beta to the full market return gives 12.6%.

  1. A8.4%
  2. B11.4%Correct
  3. C12.6%

Explanation

Required return = 3% + 1.4 × (9% − 3%) = 3% + 8.4% = 11.4%. The 8.4% option omits the risk-free rate. The 12.6% option multiplies beta by the market return (1.4 × 9%) without subtracting the risk-free rate.

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