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You observe the following statistics in the market. The stock of YUM! Brands Inc. (the holding company of KFC, Taco Bell and Pizza Hut among others) costs $66.24 today. Analysts estimate that it will cost $71.06 one year from today and will pay a dividend of $1.14. The estimated beta for YUM! is 0.83. Microsoft (MSFT) stock sells for $31.74. Analysts estimate that it will cost $32.46 in exactly one year and that the annual dividend paid during the year will be $0.80. The estimated beta for MSFT is 0.97. Calculate the expected return for each stock. Assume that these securities are correctly priced and that analyst estimates are correct. Based on the CAPM, what is the expected return on the market portfolio? What is the risk-free rate? These are real data (source YahooFinance). Do the answers you derive here match your knowledge of current T-Bill rates in the market? Do you still trust the analysts? Hint: If the CAPM is correct, then the security market line implies that all assets have the same risk premium, so you may solve for the risk-free rate by setting the reward to risk ratios of YUM! equal to those of MSFT.
The reward to risk ratio = (the expected return on the asset - Risk Free rate)/Beta_asset
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