Financial Risk Manager Part 1
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Assume you are a junior portfolio analyst for a Chinese asset management company based in Beijing and you are given the task to evaluate the stock of Sun Cruise Inc. using CAPM. If the expected return of the market is 17%, the stock beta is 0.89, the risk-free rate is 6%, and the market risk premium is 11%, then the computed expected rate of return of Sun Cruise Inc. is:
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Explanation:
Explanation
According to the Capital Asset Pricing Model (CAPM):
Expected return of a stock = Risk-free rate + Beta × (Expected market return – Risk-free rate)
Given:
- Risk-free rate = 6%
- Beta = 0.89
- Expected market return = 17%
- Market risk premium = 11%
Calculation: Expected return of Sun Cruise Inc. = 6% + 0.89 × (17% – 6%) = 6% + 0.89 × 11% = 6% + 9.79% = 15.79% ≈ 15.8%
Alternative calculation using market risk premium: Expected return = Beta × Market risk premium + Risk-free rate = 0.89 × 11% + 6% = 9.79% + 6% = 15.79% ≈ 15.8%
Both methods yield the same result, confirming that option B (15.8%) is correct.
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