FRM Part II · FRM Exam Part II · Factors
Under the CAPM, a stock has a beta of 1.4, the risk-free rate is 3%, and the expected market return is 8%. What is the stock's expected return?
The CAPM expected return is 10.0%. It equals the risk-free rate of 3% plus beta of 1.4 times the market risk premium of 5%, which adds 7%. Only systematic risk, measured by beta, is compensated in the CAPM.
- A10.0%Correct
- B11.2%
- C12.4%
- D9.2%
Explanation
Expected return = 3% + 1.4 × (8% − 3%) = 3% + 7% = 10.0%. The 11.2% figure results from multiplying beta by the market return and not subtracting the risk-free rate properly (1.4 × 8%). The 9.2% figure results from adding 1.4 × 3% ... mis-specified premium.
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