# 12 risk free rate of return 6 0 1 beta the capm

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Unformatted text preview: = the required return on security j, security krf = the risk-free rate of interest, βj = the beta of security j, and km = the return on the market index. index. Example: Example: Suppose the Treasury bond rate is Suppose 6%, the average return on the 6% S&P 500 index is 12%, and Walt 12% Disney has a beta of 1.2. 1.2 According to the CAPM, what According CAPM what should be the required rate of return on Disney stock? return kj = krf + β (km - krrff ) kj = .06 + 1.2 (.12 - .06) kj = .132 = 13.2% 13.2% According to the CAPM, Disney According stock should be priced to give a 13.2% return. 13.2% Required Required rate of rate return return SML . 12% Risk-free rate of return (6%) 0 1 Beta Required Required rate of rate return return Theoretically, every Theoretically, security should lie on the SML on SML . 12% Risk-free rate of return (6%) 0 1 Beta Required Required rate of rate return return Theoretically, every Theoretically, security should lie on the SML on SML . 12% If every stock is on the SML, is investors are being fully investors compensated for risk. compensated Risk-free rate of return (6%) 0 1 Beta Required Required rate of rate return return If a security is above the SML, it is underpriced. SML . 12% Risk-free rate of return (6%) 0 1 Beta Required Required rate of rate return return If a security is above the SML, it is underpriced. SML . 12% If a security is If below the SML, it is overpriced. is Risk-free rate of return (6%) 0 1 Beta...
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