Answer (D) is correct . The CAPM adds the risk-free rate to the product of the beta coefficient and the difference between the market return and the risk-free rate. The market-risk premium is the amount above the risk-free rate for which investors must be compensated to induce them to invest in the company. The beta coefficient of an individual stock is the correlation between volatility (price variation) of the stock market and the volatility of the price of the individual stock. Thus, the required rate is 16% [6% + 1.25 (14% – 6%)].
Answer (A) is incorrect because This percentage is the risk-free rate based on insured government securities and bears no relation to the return of the stock market.
Answer (B) is incorrect because This percentage is calculated by multiplying the beta times the risk-free rate; the beta should be multiplied times the risk premium that is required by investors.
Answer (C) is incorrect because This percentage is calculated by multiplying the market rate times beta. This ignores the risk premium. The beta should be multiplied times the risk premium that is desired by investors.
|
