How to Calculate the Required Rate of Return on a Stock with CAPM

What is the required rate of return on a stock with a beta of 1.20?

a) 8.98%
b) 9.59%
c) 11.68%
d) 12.19%
e) 13.98%

Final answer:

The required rate of return on a stock with a beta of 1.20 can be calculated using the CAPM formula, resulting in an expected return of 11.68%.

The required rate of return on a stock can be calculated using the Capital Asset Pricing Model (CAPM), which is a tool used in finance to determine a theoretically appropriate required rate of return of an asset, considering the asset's relative risk compared to the market. The formula for CAPM is given by:

Re = Rf + β(Rm - Rf)

Where:

• Re is the expected return on the capital asset
• Rf is the risk-free rate
• β (beta) is the beta of the asset
• Rm is the expected return of the market

Given that the risk-free rate (Rf) is 4.0%, the expected return of the market (Rm) is 10.4%, and the stock's beta (β) is 1.20, we can calculate the expected return on the stock (Re):

Re = 4.0% + 1.20(10.4% - 4.0%)

Re = 4.0% + 1.20(6.4%)

Re = 4.0% + 7.68%

Re = 11.68%

Therefore, the correct answer is c) 11.68%.