The Treasury bill rate is 7%, and the expected return on the market portfolio is

Question

The Treasury bill rate is 7%, and the expected return on the market portfolio is 12%. According to the capital asset pricing model a. What is the risk premium on the market? risk premium b. What is the required return on an investment with a beta of 1.6? (Do not idind intermediate calculations. Enter your percent rounded to 1 decimal place.) r as a Return on invest C. If an investment with a beta of 0.6 offers an expected return of 8.0%, does it have a positive or negative NPV? O Positive O Negative

Explanation / Answer

a) Market risk premium is the return of the market over and above the risk free rate. It is given by -

Market risk premium = Rm - Rf = 12% - 7% = 5%

b) Expected return as per CAPM is -

ER = Rf + Beta x Market Risk Premium

or, ER = 7% + 1.6 x 5% = 15%

c) The stocks expected return as per CAPM is -

ER = 7% + 0.6 x 5% = 10%

Expected return is more than the return provided, so its NPV is negative.

d) ER = Rf + Beta x Market Risk Premium

or, 10.6% = 7% + Beta x 5%

or, Beta = 0.72

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