A stock has a beta of 1.26, the expected return on the market is 9 percent, and the risk-free rate is 4 percent. What must the expected return on this stock be?

Problem 13-13 Using CAPM [LO4]

A stock has a beta of 1.26, the expected return on the market is 9 percent, and the risk-free rate is 4 percent. What must the expected return on this stock be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer

CAPM states the relationship between the risk of an asset and its expected return. CAPM is:

E(Ri) = Rf + [E(RM) − Rf] × βi

Substituting the values we are given, we find:

E(Ri) = .040 + (.09 − .040)(1.26)

E(Ri) = .1030, or 10.30%