Question

Stock A's stock has a beta of 1.30, and its required return is 16.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Select the correct answer.

a. 11.61%

b. 11.63%

c. 11.67%

d. 11.65%

e. 11.69%

Answer 1

The Correct Answer is C. 11.67% As per Capital Asset Pricing Model (CAPM) Re-Rf + (Rm-Rf) β where Re = Required Return Rf = Risk free rate of return Rm - Market Return or Expected Return on Market β-Beta of the stock Market Risk Premium Rm-Rf Calculation of Market Risk Premium or Rm - Rf using data of Stock A Re 16 Rf = 4.75 p 1.30 Using the formula Re : Rf + (Rm-Rf) β 16 4.75 (Rm-4.75) 1.30 16-4.75 (Rm-4.75) 1.30 11.25 1.30 Rm 6.175 11.25 + 6.175-1.30 Rmm 17.425-1.30 Rm Rm 13.40 Therefore Market Risk Premium = Rm-Rf 13.40 4.75 8.65 Or 8.65%