CMA Final · Strategic Financial Management · Asset Pricing Theories
Under the Capital Asset Pricing Model, the risk-free rate is 6%, the expected market return is 13% and a stock of Kaveri Textiles has a beta of 1.4. What is the required return on the stock?
The required return is 15.8%. CAPM adds the beta-scaled market risk premium to the risk-free rate: 6% plus 1.4 times the 7% premium (13% minus 6%), which is 9.8%, giving 15.8%.
- A15.8%Correct
- B18.2%
- C13.0%
- D9.8%
Explanation
Required return = Rf + beta x (Rm - Rf) = 6% + 1.4 x 7% = 6% + 9.8% = 15.8%. Option 9.8% is wrong because it omits the risk-free rate, giving only the risk premium. Option 18.2% wrongly adds 1.4 x 13% to 6%... actually it uses beta times Rm plus nothing else, an incorrect base.
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