In CAPM, the required return is computed as risk-free rate plus beta times what?

In CAPM, the required return is computed as risk-free rate plus beta times what?

• A. Market return
• B. Market risk premium
• C. Beta
• D. Inflation

Answer: (B)

CAPM expresses the required return as the risk-free rate plus beta times the market risk premium. The market risk premium is the extra return investors demand for bearing overall market risk, defined as the expected market return minus the risk-free rate. Beta shows how much the asset’s returns move with the market, so it scales that premium to match the asset’s risk. The correct term to multiply by beta is the market risk premium, not the raw market return or inflation. For example, if the risk-free rate is 2%, the expected market return is 8% (making the market risk premium 6%), and the asset’s beta is 1.2, the required return would be 2% + 1.2 × 6% = 9.2%.

CAPM expresses the required return as the risk-free rate plus beta times the market risk premium. The market risk premium is the extra return investors demand for bearing overall market risk, defined as the expected market return minus the risk-free rate. Beta shows how much the asset’s returns move with the market, so it scales that premium to match the asset’s risk. The correct term to multiply by beta is the market risk premium, not the raw market return or inflation. For example, if the risk-free rate is 2%, the expected market return is 8% (making the market risk premium 6%), and the asset’s beta is 1.2, the required return would be 2% + 1.2 × 6% = 9.2%.