FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
The risk-free rate is 3%, the expected return on the market portfolio is 9%, and a stock has a beta of 1.4. Using the CAPM, what is the stock's required return?
The required return is 11.4%. CAPM adds the risk-free rate of 3% to beta times the market risk premium: 1.4 multiplied by 6% equals 8.4%, so the total is 11.4%.
- A11.4%Correct
- B12.6%
- C8.4%
- D13.4%
Explanation
Required return = 3% + 1.4 × (9% − 3%) = 3% + 8.4% = 11.4%. The 12.6% option is 9% × 1.4, which ignores the risk-free rate and applies beta to the total market return instead of the premium. The 8.4% option leaves out the risk-free rate.
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