CFA Practice Question

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

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.
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