Use the capital-asset pricing model to predict the returns next year of the following stocks, if you expect the return to holding stocks to be 12 percent on average, and the interest rate on three-month T-bills will be two percent. Calculate a stock with a beta of -0.3, 0.7, and 1.6. Show your work for three separate calculations.
To calculate the predicted returns using the capital asset pricing model (CAPM), you will need the following information: the risk-free rate (RF), the expected market return (RM), and the beta coefficient (β) of each stock.
First, let's clarify the given information:
RF (Risk-free rate) = 2%
RM (Expected market return) = 12%
Now, let's calculate the predicted returns for each stock using the CAPM formula:
For a stock with a beta of -0.3:
Expected Return = RF + β * (RM - RF)
= 0.02 + (-0.3) * (0.12 - 0.02)
= 0.02 + (-0.3) * 0.1
= 0.02 - 0.03
= -0.01
Therefore, the predicted return is -1%.
For a stock with a beta of 0.7:
Expected Return = RF + β * (RM - RF)
= 0.02 + 0.7 * (0.12 - 0.02)
= 0.02 + 0.7 * 0.1
= 0.02 + 0.07
= 0.09
Therefore, the predicted return is 9%.
For a stock with a beta of 1.6:
Expected Return = RF + β * (RM - RF)
= 0.02 + 1.6 * (0.12 - 0.02)
= 0.02 + 1.6 * 0.1
= 0.02 + 0.16
= 0.18
Therefore, the predicted return is 18%.
To calculate the predicted returns using the CAPM model, use the formula:
Expected Return = RF + β * (RM - RF)
Replace the values of RF, RM, and β for each stock to calculate the predicted returns.