Chapter 8, Problem

Summary Introduction

Capital asset pricing model (CAPM) is one of the methods used to calculate the cost of equity which show the relationship between expected return and risk of an investment. It describes that the expected return of the security is equal to the sum of rate of return of an investment and risk premium.

$r=r_{RF}+\beta \times R{P}_M$

Here,

The cost of equity or required rate of return is “r”.

The risk-free rate is “$r_{RF}$”.

The risk premium is “$R{P}_M$” which is calculated as $\left(r_M-r_{RF}\right)$.

The market return is “$r_M$”.

The beta coefficient is “$\beta$”.

The beta coefficient of stock V is 2.0 and stock W is 0.5. The expected market rate of return is 11% and risk-free rate is 5%.