question archive Suppose the risk-free return is 2% and the market portfolio has an expected return of 12% and a volatility of 16%
Suppose the risk-free return is 2% and the market portfolio has an expected return of 12% and a volatility of 16%
Subject:FinancePrice:2.86 Bought7
Suppose the risk-free return is 2% and the market portfolio has an expected return of 12% and a volatility of 16%. Merck & Co. (Ticker: MRK) stock has a 25% volatility and a correlation with the market of 0.8.
a. What is Merck’s beta with respect to the market?
b. Under the CAPM assumptions, what is its expected return?
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a. Beta is computed as follows:
= correlation of market x (volatility of stock / volatility of market)
= 0.8 x (25 / 16)
= 0.8 x 1.5625
= 1.25
b. Expected return is computed as follows:
= Risk free rate + Beta x (Return on market - risk free rate)
= 2% + 1.25 x (0.12 - 0.02)
= 2% + 1.25 x 0.10
= 2% + 12.5%
= 14.5%
