IAI Actuarial Core Principles · Business Finance · Key principles of finance
The risk-free rate is 6%, the expected market return is 12% and a share of Kaveri Textiles Ltd has a beta of 1.5. Using CAPM, what is the required return on the share?
The required return is 15%. CAPM gives the risk-free rate of 6% plus beta of 1.5 times the market risk premium of 6%, which is 9%, totalling 15%. Forgetting to add the risk-free rate would give 9%.
- A9.0%
- B15.0%Correct
- C18.0%
- D13.5%
- 12.0%
Explanation
Required return = 6% + 1.5 × (12% − 6%) = 6% + 9% = 15%. Option 18% results from multiplying beta by the market return (1.5 × 12%). Option 9% is only the risk premium without the risk-free rate added.
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