The Capital Asset Pricing Model

(CAPM)
Presented by Syndicate 10:

Frans Joflin Pangabean (29114766)

Karina Larasati (29114721)
Lina Setiawati (29114748)
Marnala Joshua (20114880)

Capital Asset Pricing

Model (CAPM)
CAPM : The relationship
between RISK and EXPECTED
RETURN
expected return on market
Expected return on
individual securities

Expected Return on Market

E(RM) = RF + Risk Premium

E(RM) : Expected return on market

RF : The risk-free rate
Risk Premium : E(RM) - RF

Expected Return on Individual

Securities
E(R) = RF + x [E(RM) - RF ]

E(R) : Expected return on individual

market
RF : The risk-free rate
: Beta coefficient
E(RM) : Expected return on market

Beta Coefficient
()

Measure of an assets risk in relation to the

market
Magnification factor
A measurement of the responsiveness of a
security to movements in the market portfolio

= 1 the expected return on the security = the

expected return on the market
> 1 the expected return on the security will be more
volatile than expected return on the market
< 1 the expected return on the security will be less
volatile than expected return on the market
> 1 the expected return on the security = the riskfee rate

Problem 11
You own a stock portfolio invested :
25
20
15
40

percent
percent
percent
percent

in
in
in
in

stock
stock
stock
stock

Q, with beta 0.75

R, with beta 1.90
S, with beta 1.38
T, with beta 1.16

What is the portfolio beta ?

The beta of a portfolio is the sum of the weight

of each asset times the beta of each asset. So,
the beta of the portfolio is:

P = 0.25(.75) + 0.20(1.90) +
0.15(1.38) +
0.40(1.16)
= 1.24
So, the Portfolio Beta is 1.24

Problem 12
You own a portfolio equally invested in
a risk-free asset and two stocks. If one
of the stocks has a beta of 1.85 and the
total portfolio is equally as risky as the
market, what must the beta be for the
other stock in your portfolio ?

The beta of a portfolio is the sum of the weight of

each asset times the beta of each asset. If the
portfolio is as risky as the market it must have the
same beta as the market. Since the beta of the
market is one, we know the beta of our portfolio is
one. We also need to remember that the beta of the
risk-free asset is zero. It has to be zero since the
asset has no risk. Setting up the equation for the
beta of our portfolio, we get :

P = 1.0 = 1/3(0) + 1/3(1.85)

+ 1/3(x)
Solving for the beta of Stock X, we get:

X = 1.15

Problem 13
A stock has a Beta of 1.25, the expected
return on the market is 12 percent, and
the risk-free rate is 5 percent. What must
the expected return on this stock be?

=
1.25
RM =
12%
RF =

Expected Return ?

CAPM states the relationship between the risk

of an asset and its expected return. CAPM is:

E(Ri) = Rf + [E(RM) Rf]

Substituting the values we are given, we find:

E(Ri) = 0.05 + (0.12 0.05)

(1.25)
= 0.05 + 0.070 (1.25)
= 0.138 or 13.8%

Problem 14
A stock has an expected return of 14.2
percent, the risk-free rate is 4 percent,
and the market risk premium is 7
percent. What must the beta of this
stock be?

E(Ri) = 1.42
Rf = 4 %
Risk Premium =
7%

So, the
?

We are given the values for the CAPM except for

the of the stock. We need to substitute these
values into the CAPM, and solve for the of the
stock. One important thing we need to realize is
that we are given the market risk premium. The
market risk premium is the expected return of
the market minus the risk-free rate. We must be
careful not to use this value as the expected
return of the market. Using the CAPM, we find:

E(Ri) = Rf + Risk Premium ()

E(Ri) = 0.142 = 0.04 + 0.07
So, the is 1.46

Problem 15
A stock has an expected
return of 10.5 percent, its
beta is 0.73, and the risk-free
rate is 5.5 percent. What
must the expected return on
the market be?

Here we need to find the expected

return of the market using the CAPM.
Substituting the values given, and
solving for the expected return of the
market, we find:
E(Ri) = 0.105 = 0.055 + [E(RM)
0.055] (0.73)

E(RM) = 0.1235 or 12.35%

Problem 16
A stock has an expected
return of 16.2 percent, a beta
of 1.75, and the expected
return on the market is 11
percent. What must the riskfree rate be?

Here we need to find the risk-free rate using

the CAPM. Substituting the values given, and
solving for the risk-free rate, we find:

E(Ri) -> 0.162 = Rf + (0.11

Rf) (1.75)
0 .162 = Rf + 0.1925 1.75
Rf
Rf = 0.0407 or 4.07%

Thank
You!