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SteveS, MBA

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(Beta and required return) The riskless return is currently

Customer Question

(Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here. a. Calculate the expected returns on the stock market and on Chicago Gear stock. b. What is Chicago Gear’s beta? c. What is Chicago Gear’s required return according to the CAPM? Realized Return State of the Market Probability that State Occurs Stock Market Chicago Gear Stagnant .20 10% 15% Slow growth .35 10 15 Average growth .30 15 25 Rapid growth .15 25 35

I'd be happy to expalin whatever you are unclear on. I wasn't sure if you need more explanation than rM - E(rM). Just let me know.

To get the covariance between the stock market and Chicago Gear, you need to multiply each probability by (rM - E(rM)) and (rCG - E(rCG)). There are going to be four of these, representing each state of the market. The covariance is the sum of these four terms.

rM is the stock market return in each state of the market. For example, rM = -10% in the stagnant state. E(rM) is the expected return of the market. This is the weighted average of the stock market returns in the four states. 20%*-10%+35%*10%+30%*15%+15%*25% = 9.8%