ACCA Financial Management (F9) Certification Practice Exam

In the Capital Asset Pricing Model, which variable indicates the expected return on the market?

1. E(Rm)

2. B

3. Rf

4. Ke

The correct answer is: E(Rm)

In the Capital Asset Pricing Model (CAPM), the variable that signifies the expected return on the market is denoted as E(Rm). This representation is crucial because it encapsulates the anticipated returns that investors expect from holding a diversified portfolio of risky assets relative to the risk-free rate. The expected return on the market is fundamental to the CAPM as it serves as the benchmark against which individual asset returns are assessed. It is used in calculating the risk premium, which is the excess return that an investor expects over the risk-free rate as compensation for the risk of investing in the market. Understanding this, E(Rm) is vital for determining the overall expected return for any asset when factoring in its systematic risk, represented by beta (B). The formula for CAPM, which is Ke = Rf + B(E(Rm) - Rf), illustrates how the expected market return contributes to the calculation of the required return on an individual asset, highlighting its central role in financial decision-making and investment analysis. This aligns perfectly with the principles of risk and return in finance, making E(Rm) the correct identification for expected market returns.