Category: Business and Money > Finance
Asked by: baseball2-ga
List Price: $5.00
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? Thanks
Answered By: websearcher-ga on 24 Jul 2005 19:34 PDT
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. Sources: Capital asset pricing model URL: http://en.wikipedia.org/wiki/Capital_Asset_Pricing_Model Free Money and the Capital Asset Pricing Model URL: http://www.sherlockinvesting.com/articles/capm.htm Capital Asset Pricing Model URL: http://22.214.171.124/EnlightenmentorAreas/finance/CFA/capm.htm Search Strategy (on Google): * CAPM beta "risk free" interest "risk premium" I hope this helps. websearcher
rated this answer:
Thank you very much! Very helpful.
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