Question

You are analyzing a stock that has a beta of 1.25. The​ risk-free rate is 3.7 % and you estimate the market risk premium to be 5.9 %. If you expect the stock to have a return of 13.2 % over the next​ year, should you buy​ it? Why or why​ not? The expected return according to the CAPM is nothing​%. ​(Round to two decimal​ places.) Should you buy the​ stock? ​(Select the best choice​ below.)

Answer 1

6.45% and no

Step-by-step explanation:

As we know that

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 3.7% + 1.25 × (5.9% - 3.7%)

= 3.7% + 1.25 × 2.2%

= 3.7% + 2.75%

= 6.45%

he Market rate of return - Risk-free rate of return) is also known as the market risk premium and the same is applied.

Now the next year expected rate of return is 13.2% so based on this the investor should not buy this stock as the calculated expected rate of return is less than the desired expected rate of return