Explanation

Using the Capital Asset Pricing Model (CAPM):

Formula: Expected return on stock = Risk-free rate + Beta × (Market return - Risk-free rate)

Given:

• Expected return on stock = 12%
• Risk-free rate = 6%
• Beta = 1.5
• Market return = 10%

Calculation: $12\% = 6\% + 1.5 \times (10\% - 6\%)$ $12\% = 6\% + 1.5 \times 4\%$ $12\% = 6\% + 6\%$ $12\% = 12\%$ ✓

The market risk premium is defined as: $\text{Market Risk Premium} = \text{Market Return} - \text{Risk-free Rate}$ $\text{Market Risk Premium} = 10\% - 6\% = 4\%$

Therefore, the market risk premium is 4%, which corresponds to option B.