Suppose the risk-free return is 4.0% and the market portfolio has an expected return of 10.0% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.75. What is its expected return? The expected return is %. (Round to two decimal places.)
Suppose the risk-free return is 4.0% and the market portfolio has an expected return of 10.0% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.75. What is its expected return? The expected return is %. (Round to two decimal places.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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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.
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![### Question 1: Calculating Expected Return Using the CAPM Model
**Problem Statement:**
Suppose the risk-free return is 4.0% and the market portfolio has an expected return of 10.0% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.75. What is its expected return?
**Solution:**
To compute the expected return of Johnson & Johnson Corporation stock using the Capital Asset Pricing Model (CAPM), we can use the formula:
\[ \text{Expected Return} = \text{Risk-free Return} + \beta \times (\text{Market Return} - \text{Risk-free Return}) \]
Given:
- Risk-free return (\( R_f \)) = 4.0%
- Market return (\( R_m \)) = 10.0%
- Beta (\( \beta \)) of Johnson & Johnson Corporation stock = 0.75
Plugging in the values:
\[ \text{Expected Return} = 4\% + 0.75 \times (10\% - 4\%) \]
\[ \text{Expected Return} = 4\% + 0.75 \times 6\% \]
\[ \text{Expected Return} = 4\% + 4.5\% \]
\[ \text{Expected Return} = 8.5\% \]
Therefore, the expected return is:
\[
\text{The expected return is} \boxed{8.50\%}.
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Transcribed Image Text:### Question 1: Calculating Expected Return Using the CAPM Model
**Problem Statement:**
Suppose the risk-free return is 4.0% and the market portfolio has an expected return of 10.0% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.75. What is its expected return?
**Solution:**
To compute the expected return of Johnson & Johnson Corporation stock using the Capital Asset Pricing Model (CAPM), we can use the formula:
\[ \text{Expected Return} = \text{Risk-free Return} + \beta \times (\text{Market Return} - \text{Risk-free Return}) \]
Given:
- Risk-free return (\( R_f \)) = 4.0%
- Market return (\( R_m \)) = 10.0%
- Beta (\( \beta \)) of Johnson & Johnson Corporation stock = 0.75
Plugging in the values:
\[ \text{Expected Return} = 4\% + 0.75 \times (10\% - 4\%) \]
\[ \text{Expected Return} = 4\% + 0.75 \times 6\% \]
\[ \text{Expected Return} = 4\% + 4.5\% \]
\[ \text{Expected Return} = 8.5\% \]
Therefore, the expected return is:
\[
\text{The expected return is} \boxed{8.50\%}.
\]
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