CMA Final · Strategic Financial Management · Asset Pricing Theories
Under CAPM, a stock of Kaveri Textiles has a beta of 1.4. The risk-free rate is 6% and the expected return on the market portfolio is 12%. What is the required return on the stock?
The required return is 14.4%. CAPM adds a beta-scaled market risk premium to the risk-free rate: 6% plus 1.4 times the 6% premium (12% minus 6%), which gives 6% plus 8.4%, or 14.4%.
- A14.4%Correct
- B8.4%
- C16.8%
- D12.0%
Explanation
Required return = Rf + beta x (Rm - Rf) = 6% + 1.4 x 6% = 6% + 8.4% = 14.4%. The option 8.4% is only the risk premium and omits the risk-free rate. 16.8% is beta x Rm, which wrongly applies beta to the whole market return.
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