Question

Stock A's stock has a beta of 1.30, and its required return is 15.25%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.) Do not round your intermediate calculations. 9.40% 11.38% 10.44% 10.76% 12.22%

Answer 1

Risk-free rate = R_F = 2.75%

Beta of stock A = β_A = 1.30

Required return on stock A = R_A = 15.25%

Suppose Market risk premium = MRP

Required return can be calculated using CAPM Equation:

R_A = R_F+(β_A*MRP)

15.25% = 2.75% + 1.30*MRP

1.30*MRP = 15.25% - 2.75%

1.30*MRP = 12.50%

MRP = 12.50%/1.30 = 9.61538461538462%

Market Risk premium = MRP = 9.61538461538462%

Beta of stock B = β_B = 0.80

Required rate of return on B's Stock = R_B

Now, required return on stock B can be calculated using CAPM as shown below:

R_B = R_F+β_B*MRP

R_B = 2.75% + 0.80*9.61538461538462% = 10.44230769%

Required rate of return on B's stock = R_B = 10.44% (Rounded to two-decimals)

Answer -> 10.44%