Company A has a beta of 0.70, while Company B's beta is 1.15. The required return...

Company A has a beta of 0.70, while Company B's beta is 1.15. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

Solutions

Expert Solution

3.04%

Step-1:Calculation of market risk premium

Market risk premium	=	Market return	-	Risk free rate
	=	11.00%	-	4.25%
	=	6.75%

Step-2:Calculation of required return of both stocks

As per Capital Asset Pricing model,

Required return	=	Risk free rate	+	Beta	*	Market risk premium

So, Required return of :

Company A	=	Risk free rate	+	Beta	*	Market risk premium
	=	4.25%	+	0.70	*	6.75%
	=	8.98%

Company B	=	Risk free rate	+	Beta	*	Market risk premium
	=	4.25%	+	1.15	*	6.75%
	=	12.01%

Step-3:Calculation of difference of required return

Difference of required return	=	12.01%	-	8.98%
	=	3.04%

jeff jeffy answered 1 year ago

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