Assume that using the Security Market Line (SML) the required rate of return (RA) on stock A is found to be half of the required return (RB) on stock B. The risk-free rate (Rf) is one-fourth of the required return on A. Return on market portfolio is denoted by RM. Find the ratio of beta of A (bA) to beta of B (bB). please show all workings and not merely : Ra = 1/2 rb Rf = 1/4 Ra
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 using the Security Market Line (SML) the required
please show all workings and not merely :
Ra = 1/2 rb
Rf = 1/4 Ra
Capital Asset Pricing Model (CAPM):
CAPM is the method of calculating the expected return on investment. The formula to calculate the expected return using the CAPM model is:
The required rate of return (RA) on stock A 1/2 return on stock B. The risk-free rate is 1/4 return on stock A. The market portfolio is RM.
Compute the beta of A (bA), using the equation as shown below:
Rearrange the above-mentioned equation to determine the beta of A as follows:
Hence, the beta of A (bA) is computed above.
Compute the beta of B (bB), using the equation as shown below:
Rearrange the above-mentioned equation to determine the beta of B as follows:
Hence, the beta of B (bB) is computed above.
Step by step
Solved in 5 steps with 7 images
