In applying the Capital Asset Pricing Model (CAPM) to estimate a firm's cost of equity capital, the beta coefficient (β) in the model represents
A) The expected dividend per share divided by the current market price per share of common stock.
B) The cost of retained earnings.
C) The yield-to-maturity on long-term bonds payable.
D) A measure of the sensitivity of the firm's stock return to fluctuations in the returns of the overall market.
E) The "market risk premium" for that firm's stock.

Question

Quizplus · Accepted Answer

The beta coefficient (β) in the CAPM model represents a measure of the sensitivity of the firm's stock return to fluctuations in the returns of the overall market. It reflects the extent to which a stock's returns move in response to changes in the market. Therefore, a higher beta means that the stock is more sensitive to market fluctuations and vice versa. A beta of 1 indicates that the stock moves in line with the market, while a beta greater than 1 indicates that the stock is more volatile than the market, and a beta less than 1 indicates that the stock is less volatile than the market.

In Applying the Capital Asset Pricing Model (CAPM) to Estimate