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Suppose that the risk-free rate is 5% and the market portfolio has an expected return of 13% with a volatility of 18%.Monsters Inc.has a 24% volatility and a correlation with the market of .60,while California Gold Mining has a 32% volatility and a correlation with the market of -.7.Assume the CAPM assumptions hold.
-Monsters' required return is closest to:
A)10.0%.
B)13.0%.
C)11.5%.
D)15.5%.

Question

Quizplus · Accepted Answer

Monsters Inc.'s required return can be calculated using the CAPM formula:
Required return = risk-free rate + beta(market risk premium)
Beta = correlation between Monsters Inc. and the market * (Monsters Inc. volatility / market volatility)
Beta = 0.60 * (0.24 / 0.18) = 0.80
Market risk premium = expected return of the market - risk-free rate
Market risk premium = 13% - 5% = 8%
Required return = 5% + 0.80(8%) = 11.4%
Therefore, Monsters Inc.'s required return is closest to 11.5% (choice C).

Use the Information for the Question(s)below