Financial Risk Manager Part 1
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Q.193 John Powel gathers the following information regarding the stock of Swisscom, an internet service provider:
- Beta for Swisscom = 0.8
- Risk-free rate = 5%
- Powel's expected rate of return for Swisscom = 7%
Use this information to determine the expected market return.
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TTanishq
A
8%
B
12%
C
7.5%
D
5%
Explanation:
Explanation
According to the Capital Asset Pricing Model (CAPM):
[ E(R_i) = R_f + (E(R_m) - R_f) \times \beta_i ]
Where:
- ( E(R_i) ) = Expected return on asset i = 7%
- ( R_f ) = Risk-free rate = 5%
- ( E(R_m) ) = Expected market return (what we're solving for)
- ( \beta_i ) = Beta of asset i = 0.8
Substituting the given values:
[ 7% = 5% + (E(R_m) - 5%) \times 0.8 ]
Solving step by step:
- [ 7% - 5% = (E(R_m) - 5%) \times 0.8 ]
- [ 2% = (E(R_m) - 5%) \times 0.8 ]
- [ \frac{2%}{0.8} = E(R_m) - 5% ]
- [ 2.5% = E(R_m) - 5% ]
- [ E(R_m) = 2.5% + 5% = 7.5% ]
Therefore, the expected market return is 7.5%._
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