Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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![**Question:**
The return on US T-Bills is 6%, inflation is 3%, and the risk premium of the S&P 500 is 12%. If a stock has a beta of 1.3, what is the expected real rate of return for the stock?
**Options:**
- ○ 13.8%
- ○ 10.5%
- ● 21.6%
- ○ 18.1%
- ○ 17.1%
The highlighted option is **21.6%**.
**Explanation:**
The expected real rate of return can be calculated using the formula:
\[ \text{Expected Return} = \text{Risk-Free Rate} + \beta \times \text{Risk Premium} \]
Where:
- **Risk-Free Rate** is the return on US T-Bills (6%).
- **Beta (β)** is a measure of the stock’s volatility compared to the market (1.3).
- **Risk Premium** is the additional return expected from the market compared to the risk-free rate (12%).
Substitute the values into the formula:
\[ \text{Expected Return} = 6\% + 1.3 \times 12\% \]
\[ \text{Expected Return} = 6\% + 15.6\% \]
\[ \text{Expected Return} = 21.6\% \]
Therefore, the expected real rate of return for the stock is 21.6%.](https://content.bartleby.com/qna-images/question/f2ab050a-d13e-4a73-9fee-dc44d5d071e8/09886fd7-8bbe-498c-88ea-4911d3b512d7/j1r95c5_processed.jpeg)
Transcribed Image Text:**Question:**
The return on US T-Bills is 6%, inflation is 3%, and the risk premium of the S&P 500 is 12%. If a stock has a beta of 1.3, what is the expected real rate of return for the stock?
**Options:**
- ○ 13.8%
- ○ 10.5%
- ● 21.6%
- ○ 18.1%
- ○ 17.1%
The highlighted option is **21.6%**.
**Explanation:**
The expected real rate of return can be calculated using the formula:
\[ \text{Expected Return} = \text{Risk-Free Rate} + \beta \times \text{Risk Premium} \]
Where:
- **Risk-Free Rate** is the return on US T-Bills (6%).
- **Beta (β)** is a measure of the stock’s volatility compared to the market (1.3).
- **Risk Premium** is the additional return expected from the market compared to the risk-free rate (12%).
Substitute the values into the formula:
\[ \text{Expected Return} = 6\% + 1.3 \times 12\% \]
\[ \text{Expected Return} = 6\% + 15.6\% \]
\[ \text{Expected Return} = 21.6\% \]
Therefore, the expected real rate of return for the stock is 21.6%.
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