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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

The risk-free rate is 3.0%, the expected market return is 9.0%, and a stock has a beta of 1.25. The stock's required return under the CAPM is closest to:

The required return is about 10.5%. Using CAPM, add the risk-free rate of 3.0% to beta of 1.25 times the market risk premium of 6.0%, which is 7.5%. The premium is the market return minus the risk-free rate.

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

Explanation

Required return = 3.0% + 1.25 × (9.0% − 3.0%) = 3.0% + 7.5% = 10.5%. Using 1.25 × 9.0% = 11.25% plus 3% would give 14.25%, and adding beta to the market return alone gives wrong results; 12.0% arises from omitting the subtraction of the risk-free rate incorrectly (3% + 1.25 × 9% × 0.8).

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