Suppose the expected return on the market portfolio is 13.7 percent and the risk rate is 4.

8
percent. Morrow Inc. stock has a beta of 1.3 . Assume the capital-asset pricing model
holds.

What is the expected return on morrow stock?

If the risk free decreases to 4 percent, what is the expected return on morrow's stock?

a. what financial concept or principle is the problem trying to solve?

The financial concept or principle that the problem is trying to solve is the calculation of
the expected return on a stock given that the CAPM holds. Additionally it is trying to
solve the relationship between the expected return and changes in the risk free rate.

b. In the context of the problem scenario, what are some business

decisions that a manager would be able to make after solving the

problem?

After solving the problem, the manager would be able to decide on the return to offer on
the companys stock so that the stock would become an attractive investment for
investors. The manager would be able to do so by offering a rate of return that is
comparative to stocks of same risk.

c. is there any additional information that the problem should include for a manager
to make a decision based on the problem and the results of the problem?

The market risk premium is dependent on the risk free rate. Changes in risk free rate
would also lead to changes in market return. Thus if we have to find the expected return
on the stock when the risk free rate changes, we should also be given the market returns.
Else we have to assume that the market risk premium does not change.

d. without showing calculations explain in writing how you would solve the problem.

Start with the CAPM equation which is

Expected Return = Risk free rate + ( Market Return-Risk free rate) X beta

Substitute the values for the variables which are given in the question.

The answer is the expected return.

For the second part, we have to assume that the market risk premium ( market return-risk
free rate) does not change and calculate the new expected return.