CFA Practice Question
A security has a covariance of 385 with the market return. The risk-free rate of return is 4.5% and the market is expected to earn 8%. If the standard deviation of the market return is 17, what is the required rate of return on the security?
A. 8.54%
B. 9.16%
C. 15.16%
Explanation: We first need to find the systematic risk or beta of the security.
BetaS = CovarianceSM / VarianceM = 385 / 172 = 1.33
Required return = 4.5 + (8.0 - 4.5) x 1.33 = 9.16%
BetaS = CovarianceSM / VarianceM = 385 / 172 = 1.33
We apply the security market line equation to find the required return:
Required return = 4.5 + (8.0 - 4.5) x 1.33 = 9.16%
User Contributed Comments 2
| User | Comment |
|---|---|
| localabel | Why don't you use the the standard deviation of the market return in the second part. Shouldn't the equation be E(R) = Rf + ((E(R) - Rf)/Std Deviation) x Beta? |
| localabel | Its a single security, not a portfolio. Ok i got it. |