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 Subject: Finance Category: Business and Money > Finance Asked by: lrdgz-ga List Price: \$10.00 Posted: 18 Sep 2005 12:25 PDT Expires: 18 Oct 2005 12:25 PDT Question ID: 569423
 ```Suppose the expected return on a market portfolio is 14.7% and the risk-free rate is 4.9%. This company's stock has a beta of 1.3. If we assume the CAPM holds, (a) what is the expected return on Solomon's stock?, and (b) if the risk-free rate decreases to 3.7%, what is the expected return on the stock?``` Clarification of Question by lrdgz-ga on 18 Sep 2005 13:22 PDT ```I would appreciate a response within the next couple of hours. I'll make it worth your while in a tip! Thanks in advance for expediting your response.```
 ```Lrdgz ? There are several good references to the capital-asset pricing model on the Internet, including Wikipedia: Wikipedia ?Capital Asset Pricing Model,? (Sept. 15, 2005) http://en.wikipedia.org/wiki/Capital_asset_pricing_model CAPM MODEL ============ The CAPM model says that the return to investors (and to the corporation, Rc) has to be equal to: ? the risk-free rate ? PLUS a premium for stocks as a whole that is higher than the risk-free rate. This market return premium is (rM ? rf) ? And the market return should be multiplied by the risk factor for the individual company, termed the ?beta of the corporation? (ßc) Expressed as a formula, it?s: Rc = rf + ßc(rM - rf) Where, Rc is the company's expected return on capital rf is the risk-free return rate, usually a long-term U.S. Treasury bill rate rM is the expected return on the entire market of all investments. Most measures use a common broad index, most often the S&P500 over the past 5 or 10 years ßc is the company's Beta, based on its covariance with the market. SOLOMON?S CAPM ================ In the first scenario it is ? Rc = 4.9% + 1.3 * 9.8% = 17.64% In the second scenario it is: Rc = 3.7% + 1.3 * 11 = 18% There are many assumptions behind the CAPM you may want to note from the Wikipedia link above. A critical assumption in this ? with a 1.2% drop in the T-bill or risk-free rate ? is that market returns don?t change. Often lower T-bill rates result in lower Rm numbers. Google search strategy: Capital asset pricing model Best regards, Omnivorous-GA```
 lrdgz-ga rated this answer: and gave an additional tip of: \$5.00 ```Wow! You make it look so easy. Thanks so much for simplifying it for me. I have a couple of other questions I'll be posting shortly.```