Question

A stock has a required return of 9%; the risk-free rate is 3%; and the market risk premium is 3%.

1. What is the stock's beta? Round your answer to two decimal places.
2. If the market risk premium increased to 8%, what would happen to the stock's required rate of return? Assume the risk-free rate and the beta remain unchanged.
   1. If the stock's beta is equal to 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   2. If the stock's beta is equal to 1.0, then the change in required rate of return will be less than the change in the market risk premium.
   3. If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   4. If the stock's beta is less than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   5. If the stock's beta is greater than 1.0, then the change in required rate of return will be less than the change in the market risk premium.

-Select-

New stock's required rate of return will be %. Round your answer to two decimal places.

Answer 1

a       
Required return (ke) as per CAPM = Risk free rate + (Beta*(Market risk Premium)      
9% = 3% + (Beta*3%)      
9%-3%=   = Beta*3%  
Beta = 6%/3%=   2.00  
      
so stock beta is 2.00      
      
b.      
New Market risk Premium=   8%  
So New required Return = 3% + (2*8%)      
19.00%      
      
Stock beta is greater than 1, Change in required Return is 19%-9% =10%, while Change in risk Premium is 8%-3%= 5%      
      
So Correct option is III. If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.      
      

New required Return is 19%