What would be the expected return on a stock with a beta of 1.2, when the risk free rate is 3% and the broad market index is expected to earn 8%?

What would be the expected return on a stock with a beta of 1.2, when the risk free rate is 3% and the broad market index is expected to earn 8%?
A . 7%
B . 7.4%
C . 9%
D . 9.6%

View Answer

Answer: C

Explanation:

The stock has a beta of 1.2, therefore intuitively it can be expected to earn more than the broad market index. It will earn the risk free rate, ie 3%, and 1.2 times the equity risk premium of 5% (8% – 3%). The expected returns from the stock therefore are 3% + (8% – 3%)*1.2 = 9%