In: Finance
Stock R has a beta of 2.0, Stock S has a beta of 0.65, the required return on an average stock is 10%, and the risk-free rate of return is 5%. 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.
%
Beta of Stock R = 2.0
Beta of Stock S = 0.65
The higher the Beta the more risker the Stock is. Thus, Stock R is more risker as having higher Beta
As per CAPM,
where, rf = Risk free return = 5%
Rm = Market Return or average stock return = 10%
- Beta of Stock R = 2.0
Required Return of Stock R = 5% + 2.0(10%-5%)
Required Return of Stock R = 15%
- - Beta of Stock S = 0.65
Required Return of Stock S = 5% + 0.65(10%-5%)
Required Return of Stock S = 8.25%
So, the required return on the riskier stock exceed the required return on the less risky stock = Required Return of Stock R - Required Return of Stock S
= 15% - 8.25%
= 6.75%
Thus, Required Return of Risker Stock exceed less risky stock by 6.75%
If you need any clarification, you can ask in comments.
If you like my answer, then please up-vote as it will be motivating