Question

In: Finance

A stock has a required return of 12%, the risk-free rate is 6.5%, and the market...

A stock has a required return of 12%, the risk-free rate is 6.5%, and the market risk premium is 2%.

What is the stock's beta? Round your answer to two decimal places.
If the market risk premium increased to 3%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged. Do not round intermediate calculations. Round your answer to two decimal places.
1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
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Stock's required rate of return will be %.

Expert Solution

Required rate of return = 12%

Risk free rate = 6.5%

Market risk premium = 2%

(a) As per Capital Asset Pricing Model

Required rate of return = risk free rate + Beta ( market risk premium)

Putting values in the formula

12% = 6.5% + Beta ( 2%)

12% - 6.5% = Beta (2%)

5.5% / 2% = Beta

2.75 = Beta

So, Beta of stock is 2.75

(b)

If market risk premium increase to 3% and beta and risk free rate remains constant then

Required rate of return = risk free rate + beta( market risk premium)

Required rate of return = 6.5% + 2.75 (3%)

= 6.5% + 8.25%

= 14.75%

Stock required rate of return = 14.75%

Right option is

(I) if stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in market risk premium.

Reason :- in this question , beta is 2.75 that means greater than 1 and change in required rate of return in 14.75 % - 12% = 2.75% and change in market risk premium is 3% - 2% = 1%

So, change in required rate of return is greater than change in market risk premium if beta is greater than 1.

jeff jeffy answered 1 year ago

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