Using the capital asset pricing model, what is the expected return of a stock with a beta of 1.40, when the risk-free rate is 3% and market return is 10%?

To determine the expected return of a stock using the Capital Asset Pricing Model (CAPM), the formula used is:

Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

In this case, you have:

• Beta = 1.40
• Risk-Free Rate = 3% (or 0.03 as a decimal)
• Market Return = 10% (or 0.10 as a decimal)

First, calculate the market risk premium, which is the difference between the market return and the risk-free rate:

Market Risk Premium = Market Return - Risk-Free Rate Market Risk Premium = 0.10 - 0.03 Market Risk Premium = 0.07 (or 7%)

Next, plug these values into the CAPM formula:

Expected Return = 0.03 + 1.40 * 0.07 Expected Return = 0.03 + 0.098 Expected Return = 0.128 or 12.8%

This result corresponds to a percentage of 12.80%. This demonstrates that as the stock's beta is greater than 1, it is expected to have higher volatility compared to the overall market, indicating that it should yield a