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Question (Relevant to the Series 65, Series 66, and Series 79):
Given the following assumptions for stock ABC, what is its expected return using the Capital Asset Pricing Model (CAPM)? Risk Free Rate: 2%, Expected Return on general stock market: 10%, Beta: .5, Sharpe Ratio: 3.
Answers:
A. 4%
B. 6%
C. 12%
D. 2%
Correct Answer: B. 6%
Rationale: The formula for the Capital Asset Pricing Model (CAPM) is given by the following: Return on Stock = Risk Free Rate + Beta of Stock x (Return on Market – Risk Free Rate). Plugging in for Stock ABC gives Return on Stock ABC = 2% + .5 x (10% – 2%) = 6%. Note the Sharpe Ratio is not used in the CAPM formula.
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