Question

4.   Stock A has a beta of 1.3, Stock B has a beta of 0.8, the expected rate of return on an average stock is 11%, and the risk-free rate of return is 6.5%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? (Work needed)

Answer 1

Stock A is more risky because it has a higher beta of 1.3.
Calculate the required return on the risky stock and subtract from
that the required return on the less risky stock.
Under the Capital Asset pricing model
Rs = Rf + Beta*(Rm-Rf)
Rs is the required return on the stock
Rf is the risk free rate.
Rm is the expected return on the market.
STOCK A
Rs = .065 + 1.3*(.11 - .065)
Rs = .1235.
The required return on stock A that is more risky is 12.35%.
STOCK B.
Rs = .065 + .8*(.11 - .065)
Rs = .101.
The required return on stock B that is more risky is 10.1%.
The required return on the riskier stock exceeds the required return on the less risky stock by
(12.35% - 10.1%)
2.25%.