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Answer: 14%
## Explanation According to the Capital Asset Pricing Model (CAPM), the expected return of a security is calculated as: **E(R) = Rf + β × (Rm - Rf)** Where: - **Rf** = Risk-free rate = 2% - **β** = Beta = 1.5 - **(Rm - Rf)** = Market risk premium = 8% The correlation coefficient (0.5) is not needed for the CAPM calculation, as beta already incorporates both the correlation and the relative volatility. **Calculation:** E(R) = 2% + 1.5 × 8% E(R) = 2% + 12% E(R) = 14% **Key points:** 1. The CAPM formula uses beta, not correlation directly 2. Beta already accounts for both the security's correlation with the market and its relative volatility 3. The correlation coefficient (0.5) is a distractor in this question 4. The correct answer is 14% (Option C)
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A security and the market exhibit the following characteristics:
| Risk-free rate of return | 2% |
|---|---|
| Market risk premium | 8% |
| Beta | 1.5 |
| Security's correlation with the market | 0.5 |
Based on the CAPM, the security's expected rate of return is closest to:
A
6%
B
11%
C
14%