Suppose you observe the following situation: $\begin{array}{ccc}
&& \text { Expected } \
\text { Security } & \text { Beta } & \text { Retumn } \
\mathrm{A} & 1.16 & .1137 \
\mathrm{~B} & .92 & .0984
\end{array}$
Assume these securities are correctly priced. Based on the CAPM, what is the return on the market?
A) 9.99 percent
B) 11.42 percent
C) 10.35 percent
D) 9.78 percent
E) 11.01 percent

Question

Quizplus · Accepted Answer

According to the CAPM,

Expected Return on Security A = Risk-Free Rate + Beta(A) x (Expected Return on Market - Risk-Free Rate)

Expected Return on Security B = Risk-Free Rate + Beta(B) x (Expected Return on Market - Risk-Free Rate)

We can solve for the Expected Return on Market by solving these two equations simultaneously.

Rewriting the equations, we get:

Expected Return on Market = [Expected Return on Security A - Risk-Free Rate] / Beta(A)

Expected Return on Market = [Expected Return on Security B - Risk-Free Rate] / Beta(B)

Plugging in the given values, we get:

Expected Return on Market = [0.1137 - 0.0433] / 1.16 = 0.1

Expected Return on Market = [0.0984 - 0.0433] / 0.92 = 0.1

Therefore, the return on the market is 10.35 percent, which is option C.

Suppose You Observe the Following Situation Assume These Securities Are Correctly Priced