Use the Capital Asset Pricing Model (CAPM) to calculate the required rate of ret
ID: 2812302 • Letter: U
Question
Use the Capital Asset Pricing Model (CAPM) to calculate the required rate of return for a S&P 500 stock (Links to an external site.)Links to an external site.of your choice. You must include the formula and parameters you used to calculate the answer. See below for instructions on how to find the numbers to plug into your equation:
For the risk-free rate of return, use the latest long-term US Treasuries composite (>10 years), which can be found here. (Links to an external site.)Links to an external site.
Base the expected market return on the 10-Year Trailing Total Returns (on the Daily tab - under 10-year) return of the S&P 500, which can be found here (Links to an external site.)Links to an external site..
Determine beta for your stock using Yahoo FinanceLinks to an external site. (or any other source you'd like). Enter the stock ticker in the search field at the top of the home page, and then look Beta under the summary section.
(Assume that nonsystematic risk - also known as unsystematic, specific, and diversifiable risk - is zero.)
Hint: The expected market return minus the risk-free rate equals the risk premium in the CAPM equation.
Explanation / Answer
Answer:
Capital Asset Pricing Model (CAPM) =
Company – 3M Co. (Ticker: MMM)
For the risk-free rate of return, use the latest long-term US Treasuries composite (>10 years), which can be found here. (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrate.) = 3.07% as on February 2018
Base the expected market return on the 10-Year Trailing Total Returns (on the Daily tab - under 10-year) return of the S&P 500, which can be found here (http://performance.morningstar.com/Performance/index-c/performance-return.action?t=SPX®ion=usa&culture=en-US.) = 13.01% as on February 2018
Determine beta for your stock using Yahoo Finance Links to an external site. (https://finance.yahoo.com). Enter the stock ticker in the search field at the top of the home page, and then look Beta under the summary section = 0.97 as on February 2018
(Assume that nonsystematic risk - also known as unsystematic, specific, and diversifiable risk - is zero.)
Thus, the risk-free rate is 3.07% and the beta (risk measure) of a stock is 0.97. The expected market return over the period is 13.01%, so that means that the market risk premium is 9.94% (13.01% - 3.07%) after subtracting the risk-free rate from the expected market return.
Plugging in the preceding values into the CAPM formula above, we get an expected return of 12.71% for the stock:
12.71% = 3.07% + 0.97x (13.01% - 3.07%)
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