Question

Stock R has a beta of 1.7, Stock S has a beta of 0.6, the expected rate of return on an average stock is 11%, and the risk-free rate of return is 6%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places.

Answer 1

Solution:
	Answer is 5.50 %
Working Notes:
	The required return on the riskier stock exceed the required return on the less risky stock
	Here , riskier stock is Stock R as it have higher beta than stock S
	Expected rate of return on an average stock = Market rate = rm = 11%
	Risk-free rate of return (rf) = 6%
	Beta for Stock R (Br) = 1.70
	Beta for Stock S (Bs) = 0.60
	Return on stock R (Rr) = rf + (rm-rf) x Br
	Return on stock R (Rr) =6% + (11% -6%) x 1.70
	Return on stock R (Rr) =6% + 5% x 1.70
	Return on stock R (Rr) =6% + 8.50%
	Return on stock R (Rr) =14.50%
	Return on stock S(Rs) = rf + (rm-rf) x Bs
	Return on stock S(Rs) =6% + (11% -6%) x 0.60
	Return on stock S(Rs) =6% + 5% x 0.60
	Return on stock S(Rs) =6% + 3%
	Return on stock S(Rs) = 9%
	The required return on the riskier stock exceed the required return on the less risky stock
		= Return on stock R - Return on stock S
		=14.50% - 9%
		=5.50%
Please feel free to ask if anything about above solution in comment section of the question.