The historical returns for the past four years for Stock C and the stock market portfolio were Stock C: 10 percent, 30 percent, 20 percent, 20 percent; market portfolio: 5 percent, 15 percent, 25 percent, 15 percent.If the risk-free rate of return is 5 percent and the expected market return is 12 percent, calculate the required rate of return on Stock C using the CAPM.

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Quizplus · Accepted Answer

The CAPM formula is: Required rate of return = Risk-free rate + Beta * (Expected market return - Risk-free rate)Beta = Covariance of Stock C and market portfolio / Variance of market portfolioCovariance = (10 - 5) * (5 - 12) + (30 - 15) * (15 - 12) + (20 - 25) * (25 - 12) + (20 - 15) * (15 - 12) = 100Variance = (5 - 12)^2 + (15 - 12)^2 + (25 - 12)^2 + (15 - 12)^2 = 200Beta = 100 / 200 = 0.5Required rate of return = 5% + 0.5 * (12% - 5%) = 8.5%

The Historical Returns for the Past Four Years for Stock