Question
Download Solution PDFAs per CAPM model, the required rate of return on a security is:
Answer (Detailed Solution Below)
Detailed Solution
Download Solution PDFThe correct answer is Return on Treasury Bonds + Market Risk Premium.
Key Points CAPM MODEL:
According to the Capital Asset Pricing Model (CAPM), the required rate of return on a security is calculated as the sum of the risk-free rate and the product of the security's beta (systematic risk) and the market risk premium.
The formula for calculating the required rate of return (R) on security using CAPM is as follows:
R = Rf + β * (Rm - Rf)
Where:
- Rf = the risk-free rate of return, usually the yield on government bonds
- β = the security's beta, a measure of its systematic risk relative to the overall market
- Rm = the expected market return
- (Rm - Rf) = the market risk premium, which is the excess return that investors expect to earn by investing in the market portfolio rather than a risk-free asset.
Additional Information
- The CAPM model suggests that the required rate of return on a security is directly proportional to its systematic risk (beta), and that investors demand a higher return for taking on greater risk.
- Therefore, the required rate of return on a security with a higher beta will be higher than that of a security with a lower beta, assuming all other factors remain constant.
Hence, the correct answer is Return on Treasury Bonds + Market Risk Premium.
Last updated on Jun 6, 2025
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