NISM Certifications · NISM-Series-XV: Research Analyst · Fundamentals of Risk and Return
The risk-free rate is 7%, the expected market return is 12% and a stock has a beta of 1.4. Using CAPM, what is the required return on the stock?
The required return is 14%. CAPM gives risk-free rate plus beta times market risk premium: 7% + 1.4 x (12% - 7%) = 7% + 7% = 14%. Applying beta to the full market return instead of the premium would wrongly give 16.8%.
- A14.0%Correct
- B16.8%
- C19.0%
- D12.0%
Explanation
CAPM: Rf + beta x (Rm - Rf) = 7 + 1.4 x 5 = 14%. Using 1.4 x 12 = 16.8% ignores the risk-free adjustment and applies beta to the whole market return, which is wrong.
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