Question

The interest rate on short-term U.S. government bonds is 4 percent. The risk premium for any asset with a beta = 1.0 is 6 percent. What is the average expected rate of return on the market portfolio?

Answer 1

The average expected rate of return on the market portfolio is 10 percent.

Step-by-step explanation:

The CAPM (fixed asset pricing) model describes the relationship between systematic risk and expected return on assets, especially stocks. CAPM is widely used throughout the financial community to value high-risk securities and achieve the expected returns on assets when taking into account the risk of those assets and the cost of capital.

The formula for calculating the expected return on an asset taking into account its risk is as follows:

ERi = Rf + βi (ERm - Rf)

where:

ERi = expected return on investment

Rf = risk-free interest rate = 4 percent.

βi = beta inversion =1.0

(ERm −Rf) = market risk premium = 6 percent.

ERi = 4 + 1 ×(6) =10

The average expected rate of return on the market portfolio is 10 percent.