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CMA Final · Strategic Financial Management · Asset Pricing Theories

The risk-free rate is 6% and the expected market return is 12%. Using the Capital Asset Pricing Model, what is the required return on a share of Kaveri Textiles Ltd whose beta is 1.5?

The required return is 15%. CAPM adds the beta-scaled market risk premium to the risk-free rate: 6% plus 1.5 times the 6% premium (12% minus 6%) gives 6% plus 9%, which equals 15%.

  1. A15%Correct
  2. B18%
  3. C9%
  4. D13.5%

Explanation

Required return = Rf + beta x (Rm - Rf) = 6 + 1.5 x (12 - 6) = 6 + 9 = 15%. The option 18% results from multiplying beta by the market return (1.5 x 12) instead of the premium. The option 9% is only the risk premium, with the risk-free rate left out.

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