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Q: Finance ( Answered 5 out of 5 stars,   0 Comments )
Subject: Finance
Category: Business and Money > Finance
Asked by: baseball2-ga
List Price: $5.00
Posted: 24 Jul 2005 18:55 PDT
Expires: 23 Aug 2005 18:55 PDT
Question ID: 547402
Am I figuring CAPM correct for the following scenerio:  Company B  has
a beta of 2.03 . The risk free rate of interest is 5 persence. I am
using a 9 percent risk premium for the market partolio.

.05 + 2.03 * (0.09 -0.05) = 13%  Is this correct? 

Subject: Re: Finance
Answered By: websearcher-ga on 24 Jul 2005 19:34 PDT
Rated:5 out of 5 stars
Hello baseball2:

No, you're not quite calculating CAPM correctly. 

The formula you should be using for CAPM for this question is: 

E(R) = r + ERP * beta

E(R) = expected return
r = risk-free interest rate
ERP = equity risk premium

So, for your figures, the formula is:

E(R) = r + beta * ERP
     = 5% + 9% * 2.03
     = 23.27%

The mistake you were making was confusing the risk premium with the
expected return. The more expanded version of the CAPM formula is:

E(R) = r + beta * (E(Rm) - r)

where E(Rm) is the expected return of the market and (E(Rm) - r) is
used to calculate the risk premium. So, basically, if you're given the
ERP value, you do not need to subtract the risk-free value from it -
it's already been subtracted.


Capital asset pricing model

Free Money and the Capital Asset Pricing Model

Capital Asset Pricing Model

Search Strategy (on Google):
* CAPM beta "risk free" interest "risk premium"

I hope this helps. 

baseball2-ga rated this answer:5 out of 5 stars
Thank you very much! Very helpful.

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