Question

Beta coefficient

Given the following information, determine the beta coefficient for Stock L that is consistent with equilibrium:  = 14.75%; r_RF = 3.15%; r_M = 8.5%. Round your answer to two decimal places.

Answer 1

Solution:

As per the information given in the question the stock L is consistent with equilibrium = 14.75%

This implies that as per the Capital Asset Pricing model, Equilibrium return = rE = 14.75 %

As per Capital Asset Pricing Model, Equilibrium return or expected rate of return is calculated using the following formula:

rE = rRF + [ β * ( rM – rRF ) ]

Where

rE = Equilibrium or Expected Rate of return    ; rRF = Risk free rate of return   ; rM = Market rate of return

β = Beta coefficient of the stock

As per the information given in the question we have

rRF = 3.15 %   ;    rM   = 8.5 %      ;      rE    =    14.75 %     ;    β = To find

Applying the above values in the formula we have

14.75 % = 3.15 % + [ β * ( 8.5 % - 3.15 %) ]

14.75 % = 3.15 % + [ β * ( 5.35 %) ]                                  

14.75 % - 3.15 % = [ β * 5.35 % ]

11.60 % = [ β * 5.35 % ]

Thus β = 11.60 / 5.35 = 2.17

Thus the Beta Coefficient of the stock is = 2.17 (when rounded off to two decimal places )