Question

the​ risk-free rate is 3​% and you believe that the​ S&P 500's excess return will be 10​% over the next year. If you invest in a stock with a beta of 1.2 ​(and a standard deviation of 30​%), what is your best guess as to its expected excess return over the next​ year?

Answer 1

Answer:

The expected excess return will be 11.4%

Explanation:

The S&P 500's excess return is the market return (rM). Using the CAPM model or the SML approach, we can calculate the required/expected rate of return on the stock we are investing in.

The expected rate of return is,

r = rRF + β * (rM - rRF)

Thus, return on the invested stock will be:

r = 0.03 + 1.2 * (0.1 - 0.03)

r = 0.114 or 11.4%