Question

Stock A has a beta of 0. 9 and an expected return of 7. 94%. Stock B has a beta of 1. 2 and an expected return of 9. 92%. If the CAPM holds, what is the slope of the Capital Market Line?

Answer 1

The slope of the Capital Market Line is 5.

Step-by-step explanation:

The Capital Market Line (CML) represents the relationship between expected return and beta for a well-diversified portfolio. According to the Capital Asset Pricing Model (CAPM), the equation for the CML is:

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

To determine the slope of the CML, we need the risk-free rate and the market risk premium. Let's assume the risk-free rate is 2% and the market risk premium is 5%.

For Stock A with a beta of 0.9, the expected return can be calculated as follows:

Expected Return A = 2% + (5% × 0.9) = 6.5%

For Stock B with a beta of 1.2, the expected return can be calculated as follows:

Expected Return B = 2% + (5% × 1.2) = 8%

Now, with these data points, we can plot Stock A and Stock B on the expected return (y-axis) versus beta (x-axis) graph. The slope of the CML is the line connecting these two data points:

Slope of CML = (Expected Return B - Expected Return A) / (Beta B - Beta A)

Slope of CML = (8% - 6.5%) / (1.2 - 0.9)

Slope of CML = 1.5% / 0.3

Slope of CML = 5

Therefore, the slope of the Capital Market Line is 5.