iumThis equation can be used to find any of the variables listed above, given the rest of the variables are known.
23 CAPM ExampleFind the required return on a stock given that the risk-free rate is 8%, the expected return on the market portfolio is 12%, and the beta of the stock is 2.Ki = Krf + bi(Km - Krf)Ki = 8% + 2(12% - 8%)Ki = 16%Note that you can then compare the required rate of return to the expected rate of return. You would only invest in stocks where the expected rate of return exceeded the required rate of return.
24 Another CAPM ExampleFind the beta on a stock given that its expected return is 12%, the risk-free rate is 4%, and the expected return on the market portfolio is 10%.12% = 4% + bi(10% - 4%)bi = 12% - 4%10% - 4%bi = 1.33Note that beta measures the stock’s volatility (or risk) relative to the market.