43.8
8. Stock A has a beta of 1.2. The expected return on the market
is 12% and the risk-free rate is 3%.
a.What is the expected return on stock A? (3)
E[Ra]=.03+1.2(.12-.03)=.138
b.How much of that return is compensation for risk? (4)
As we discussed in class, the CAPM formula basically says that your expected return on a security equals some risk free amount that compensates you purely for giving up your money for a year, even if you are assured of getting it back, plus some amount of compensation per unit of risk you take on, times the number of units of risk. Thus, the 3% risk free rate is the non-risk compensation and the 10.8% remaining is compensation for risk.