Suppose you are given the following information: The beta of a company, b1, is 0.9; the risk-free rates rRF, is 6.8%; and the expected market premium, rM ? rRF, is 6.3%. Because your company is larger than average and more successful than average (that is, it has a lower book to-marker ratio), you think the Fama French three-factor model might be more appropriate than the CAPM. You estimate the additional coefficients from the Fama French three-factor model: The coefficient for the size effect, c1, is ?0.5, and the coefficient for the book-to-market effect, d1, is ?0.3. If the expected value of the size factor is 4% and the expected value of the book-to-market factor is 5%, what is the required return using the Fama-French three-factor model? (Assume that ai = 0.0.) What is the required return using CAPM?
This question was answered on: Jul 11, 2017
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