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17 December, 08:26

According to the CAPM, what is the expected market return given an expected return on a security of 17.2%, a stock beta of 1.6, and a risk-free interest rate of 6%?

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  1. 17 December, 11:24
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    Expected market return is 13%

    Explanation:

    CAPM is used to calculate the expected return on an asset for decision making to add any further asset to a well diversified portfolio. It involves different factors like market risk premium, asset beta and risk free rate as well to calculate a return rate which is expected to obtain from underline asset or investment.

    As per given data

    Expected return = 17.2%

    Stock beta = 1.6

    Risk free rate = 6%

    According to CAPM

    Expected Return on security = Risk free rate + Stock beta (Market Risk Premium)

    17.2% = 6% + 1.6 * (Market Risk Premium)

    17.2% = 6% + 1.6 * (Market return - Risk free rate)

    17.2% = 6% + 1.6 * (Market return - 6%)

    17.2% - 6% = 1.6 * (Market return - 6%)

    11.2% = 1.6 * (Market return - 6%)

    11.2% / 1.6 = Market return - 6%

    7% = Market return - 6%

    7% + 6% = Market return

    Market return = 13%
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