Calculate and interpret a CAPM required return for an equity position.
Estimate the required return for a stock with beta 1.3, a 4% risk-free rate, and a 5% expected equity risk premium. CAPM required return = risk-free rate + beta equity risk premium. Comparing an equity idea to cash ignores the market risk the stock adds to the portfolio. Step 1 Risk-free rate = 4.0% This is the baseline return available before taking equity market risk. Step 2 Equity risk premium = 5.0% This is the expected compensation for owning market risk instead of the risk-free asset. Step 3 Beta adjustment = 1.3 5.0% = 6.5% The stock is estimated to…
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