Assume that the Capital Asset Pricing Model holds. The market portfolio has an expected return of 5%. Stock A’s return has a market beta of 1.5, an expected value of 7% and a standard deviation of 10%. Stock B’s return has a market beta of 0.5 and a standard deviation of 20%. The correlation coefficient between stock A’s and stock B’s returns is 0.5. What is the risk-free rate? What is the expected return on stock B?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
. Assume that the
return of 5%. Stock A’s return has a market beta of 1.5, an expected value of 7% and a
standard deviation of 10%. Stock B’s return has a market beta of 0.5 and a standard
deviation of 20%. The correlation coefficient between stock A’s and stock B’s returns is 0.5.
- What is the risk-free rate?
- What is the expected return on stock B?
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