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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Modern Portfolio Theory

Under CAPM, the risk-free rate is 7%, the expected market return is 12% and a stock of Tata Motors-like profile has a beta of 1.4. What is the required return on the stock?

The required return is 14%. CAPM gives risk-free rate 7% plus beta 1.4 times the market premium of 5% (12% minus 7%), which is 7% plus 7%. Multiplying beta by the full market return would wrongly overstate it.

  1. A14.0%Correct
  2. B16.8%
  3. C12.0%
  4. D15.4%

Explanation

Required return = 7% + 1.4 x (12% - 7%) = 7% + 7% = 14%. The 16.8% option is 1.4 x 12% (forgetting the risk-free adjustment). The 15.4% option wrongly adds 1.4 x 6%... it uses an incorrect premium base. The 12% option ignores beta.

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