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    CAPM and Expected Return

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    I need some tips on how to solve the following type of problem. Can you help??

    CAPM and Expected Return. Stock A has a beta of .5 and investors expect it to return 5 percent. Stock B has a beta of 1.5 and investors expect it to return 13 percent. Use the CAPM to find the market risk premium and the expected rate of return on the market.

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    Solution Preview

    If we are given two beta and the expected returns, both these points must lie on the Security Market Line (SML). Since the SML is a straight line we can plot the SML and the market return is the point with the beta =1. The slope of SML is the market risk premium.
    From the given data, we find that for the ...

    Solution Summary

    The solution explains how to use the CAPM equation to market risk premium and the expected return on the market.

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