Consider the capital asset pricing model.The market degree of risk aversion,A,is 3.The variance of return on the market portfolio is .0225.If the risk-free rate of return is 4%,the expected return on the market portfolio is _________.
A) 6.75%
B) 9.0%
C) 10.75%
D) 12.0%

Question

Quizplus · Accepted Answer

The capital asset pricing model (CAPM) formula is:

Expected return on asset = risk-free rate + beta * (expected return on market - risk-free rate)

Where beta is the sensitivity of the asset's return to the market, and is calculated as the covariance between the asset and the market divided by the variance of the market.

In this question, we are given:

- Market degree of risk aversion (A) = 3
- Variance of return on market portfolio = 0.0225
- Risk-free rate of return = 4%

The expected return on the market portfolio can be calculated as:

Expected return on market = risk-free rate + (market degree of risk aversion * square root(variance of return on market portfolio))

Expected return on market = 0.04 + (3 * sqrt(0.0225)) = 0.1075 = 10.75%

Therefore, the answer is C (10.75%).

Consider the Capital Asset Pricing Model