Question

HOW TO CALCULATE THESE QUESTIONS?

1. The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent. If the risk-free rate is 4 percent, calculate the market risk premium.

A. 18.1 percent

B. 14.0 percent

C. 10.0 percent

D. 6.0 percent

2. The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent. The expected market return is 12 percent. Calculate the required rate of return (cost of equity) for Stock B using the CAPM. (The risk-free rate of return = 4%.)

A. 8.6 percent

B. 12.6 percent

C. 10.9 percent

D. 16.0 percent

Answer 1

Ans 1. C. 10.0 percent

YEAR	HISTORICAL RETURN	MARKET RETURN
1	24	10
2	0	12
3	24	20
Total	48	42
Average Return =	Total Return / NO of years	Total Return / NO of years
	48 / 3	42 / 3
	16	14
Market Risk Premium =	Market Return - Risk Free Return
	14% - 4%
	10.0%