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Hi John
I am slightly confused by the CAPM calculation in this question, the beta is 1.2, the yield on short term government debt is 4.5% and equity risk premium is 5%:
I would calculate this using the formula from the sheet – E(ri)=Rf+Bi(E(rm)-Rf)
E(ri) – 4.5+(1.2(5-4.5))
E(ri) = 6.9%but the answer ignores the second Rf
it is 4.5+(1.2*5) = 10.5%Where am I going wrong?
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risk premium is Rf-Rm ,
E=Rf+B*Rp
Sylwia is correct.
If the question had said that the market equity return was 5% then your answer would have been correct. However if the exam uses the term ‘equity risk premium’ then they are already telling you the extra above the risk free rate (so in this question the actual market equity return would be 4.5% + 5% = 9.5%)
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