Question

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5. SML A stock is appropriately priced at $40 per share. At this price, the required return is 15% and 15 beta coefficient is 1.2. At this same point in time, the return on the 20-year Treasury is expected to be 3. What is the market risk premium? What should happen to the risk-free rate of return, asset pela coefficient, and required retum on the stock if the market risk premium increases to 12% from an increase in perceived market risk? 4

Answer 1

Beta =    1.2  
T-bills rate (Risk free rate)=   3%  
required Return=   15.00%  
required Return = Risk free rate + (Beta*(Market return - risk free rate of return)      
15% = 3% + (1.2*MRP)      
12%= 1.2*MRP      
MRP= 12%/1.2=   10.00%  
      
So Market risk Premium is 10%      
      
if Market risk Premium increases to 12%. Beta and risk free rate will not change, but required Return will change      
New required Return= 3% + (1.2*12%)      
17.40%      
      
So Required Return will increase to 17.40% from 15%      

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