Suppose the yield on short-term government securities (perceived to be risk-free

Question

Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 12%. According to the capital asset pricing model: a. What is the expected return on the market portfolio?
b. What would be the expected return on a zero-beta stock?

Suppose you consider buying a share of stock at a price of $40. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluated at = –.5. c-1.
Using the SML, calculate the fair rate of return for a stock with a = –0.5.
Calculate the expected rate of return, using the expected price and dividend for next year.

Explanation / Answer

Rm = 12%

Rf = 4%

Er= Rf +(Rm- Rf) xbeta

    = 4% +(12%-4%)x0

    = 4%

Er= Rf +(Rm- Rf) xbeta

    = 4% +(12%-4%)x-0.5

    = 4% -4%

    =0%

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