Consider an economy where Capital Asset Pricing Model holds. In this economy, stocks A and B have the following characteristics: Stock A has and expected return of 22% and a beta of 2. Stock B has an expected return of 15% and a beta of 0.8. The standard deviation of the market portfolio’s return is 18%. Q: Assuming that stocks A and B
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider an economy where
stocks A and B have the following characteristics:
Stock A has and expected return of 22% and a beta of 2.
Stock B has an expected return of 15% and a beta of 0.8.
The standard deviation of the market portfolio’s return is 18%.
Q: Assuming that stocks A and B are correctly priced according to the CAPM, compute the risk-free rate and the market risk premium.
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