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

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

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...
View Full Document

Ask a homework question - tutors are online