20. Consider the CAPM. The risk-free rate is 3% and the expected return on the m

Question

20. Consider the CAPM. The risk-free rate is 3% and the expected return on the market is 11%. What is the expected return on a stock with a beta of 1.95?

21. Using the data from problem 20, what is the expected return on the stock according to the Fama and French 3 factor model? The additional information you discovered is an expected return of 2.25% on the size (SMB) portfolio and an expected return of 3.50% on the book–to–market (HML) portfolio, plus the stock has a factor sensitivity or beta of –0.75 on SMB and 0.95 on HML.

Explanation / Answer

We have:

Beta = 1.95

Rf =3%

Rm= 11%

We have following formula under CAPM method for expected return on stock:

Er = Rf +(Rm-Rf)beta

     = 3% + (11%-3%)x1.95

     =18.60%

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