Question

Stock R has a beta of 1.5,Stock S has a beta of 0.75, the expected rate of return on an average stock is 13 percent, and the risk-free rate of return is 7 percent. By how much does the required return on the riskier stock exceed the required return on the less risky stock?

Answer 1

StockR                                                                     Stock S

Beta =1.5                                                                  Beta = 0.75

Expected rate of return on an average stock (R_m)= 13%

Risk free rate (R_f) = 7%

Required Return (R_e) = R_f +(R_m-R_f) B

Required Return = 0.07 + (0.13-0.07) B

StockR              = 0.07 + (0.06 * 1.50)

                           = 0.16 (or) 16%

StockS              = 0.07 + (0.06 * 0.75)

                           = 0.115 (or) 11.5%

Here more risky stock is R and less risky stock is S. Since, Rhas more beta than the Stock S.

                                               16% - 11.5% = 4.5%

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