Stock X and the "market" had the following returns during the last three years, and the same relative volatility is expected to exist in the future: Year Stock X Market
$$\begin{array} { r r }
1&150 & 10.0\
2&5.0 & 5.0 \
3&- 15.0 & - 5.0
\end{array}$$ The riskless rate is rRF = 8%, and the expected return on the market is 12 percent.If equilibrium exists, what is the expected return on Stock X?
A)?4%
B)8%
C)12%
D)14%
E)16%

Question

Stock X and the "market" had the following returns during the last three years, and the same relative volatility is expected to exist in the future: Year Stock X Market
$$\begin{array} { r r } 
1&150 & 10.0\
2&5.0 & 5.0 \
3&- 15.0 & - 5.0
\end{array}$$ The riskless rate is rRF = 8%, and the expected return on the market is 12 percent.If equilibrium exists, what is the expected return on Stock X?
A)?4%
B)8%
C)12%
D)14%
E)16%

Quizplus · Accepted Answer

The expected return on Stock X can be calculated using the Capital Asset Pricing Model (CAPM): $ E(R_x) = r_{RF} + \beta_x (E(R_m) - r_{RF}) $. First, calculate the beta ($\beta_x$) of Stock X by comparing its returns to the market returns. The beta is approximately 2, indicating Stock X is twice as volatile as the market. Using CAPM: $ E(R_x) = 8\% + 2(12\% - 8\%) = 16\% $.

Stock X and the "Market" Had the Following Returns During 115010.025.05.03−15.0−5.0\begin{array} { r r } 1&150 & 10.0\\2&5.0 & 5.0 \\3&- 15.0 & - 5.0\end{array}123​1505.0−15.0​10.05.0−5.0​

Stock X and the "Market" Had the Following Returns During $\begin{array} { r r } 1&150 & 10.0\\2&5.0 & 5.0 \\3&- 15.0 & - 5.0\end{array}$