Explanation

According to the Capital Asset Pricing Model (CAPM):

Expected return of stock = Risk-free rate + Beta × (Market return - Risk-free rate)

Given:

• Risk-free rate (10-year US Treasury) = 5%
• Market return (S&P 500) = 10%
• Beta of Orange Inc. = 1.2

Calculation: E[r] = 5% + 1.2 × (10% - 5%) E[r] = 5% + 1.2 × 5% E[r] = 5% + 6% E[r] = 11%

Key Points:

• The 10-year US Treasury bonds are considered the risk-free rate
• The S&P 500 return represents the market return
• Beta of 1.2 means the stock is 20% more volatile than the market
• The expected return of 11% compensates for both the time value of money (risk-free rate) and the additional risk premium for the stock's volatility