IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)
The risk-free rate is 6% per annum and the expected return on the market portfolio is 12% per annum. An Indian manufacturing stock has a beta of 1.4. According to CAPM, what is its required return?
The required return is 14.4%. CAPM gives the risk-free rate of 6% plus beta of 1.4 times the market premium of 6%, which is 8.4%, totalling 14.4%. Forgetting to add the risk-free rate gives 8.4%.
- A12.0%
- B14.4%Correct
- C16.8%
- D8.4%
- 18.0%
Explanation
Required return = 6% + 1.4 × (12% − 6%) = 6% + 8.4% = 14.4%. Option D gives only the risk premium without adding the risk-free rate. Option C applies beta to the market return (1.4 × 12%).
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