Question

Suppose the risk-free is 4%. If you have a stock with ? of 0.7 and the risk premium on the market is 5%, what must be the expected return of the stock assuming that the market is the only factor. Illustrate your answer graphically.

Answer 1

expected return on the stock = R_f + beta ( R_m - R_f )

where R_f is risk-free rate

R_m is expected return on market .

and ( R_m - R_f ) is the risk premium on market. that is the difference between the expected return on market and risk free invetsment rate is known as risk premium on market or equity premium.

=4% + 0.7 ( 5%)

= 4% + 3.5%

= 7.5%

so, expected return on the stock / asset is 7.5%

return Rm 9% 7.5% Af 4% Ix:i 0.7