The risk-free rate is 4%, the expected market return is 9%, and a security has a beta of 1.4. According to the Capital Asset Pricing Model, what is the security's expected return?
Correct Answer: C
Comprehensive and Detailed 150 to 250 words of Explanation From Retail Securities/Course Guide/topics]: The Capital Asset Pricing Model calculates expected return as follows: Expected return = Risk-free rate + Beta × (Market return # Risk-free rate) The market risk premium is: 9% # 4% = 5% Applying the security's beta: Expected return = 4% + 1.4 × 5% Expected return = 4% + 7% = 11% Option C is correct. A beta of 1.4 indicates that the security has greater systematic market sensitivity than an asset with a beta of 1.0. CAPM therefore assigns it a larger risk premium than the market portfolio. Option B ignores the security' s above-market beta. Option D incorrectly multiplies the market return itself by beta without first separating the risk-free return from the market risk premium. CAPM prices systematic risk because market-wide risk cannot be eliminated through diversification. Issuer- specific or unsystematic risk is not separately rewarded under the model because a diversified investor can substantially reduce it. The resulting 11% is a model-based expected or required return, not a guaranteed future return. CIRO's Retail Securities syllabus expressly requires candidates to understand asset-pricing models and apply CAPM using the risk-free rate, beta and market risk premium.
