Question

A stock has a beta of 1.5. The pure rate of interest is 2.75 percent and investors require a 3 percent inflation premium. What is the required rate of return on this stock if the market risk premium is 6 percent? (Hint: First, calculate the risk-free rate using the pure rate and the inflation premium. Next, use this risk-free rate to find the required return on the stock.)

1. A.15.7%
2. B.17.4%
3. C.13.7%
4. D.14.8%
5. E.12.9%
6. F.16.5%

Answer 1

Risk-free Rate = Real risk-free rate + Inflation Premium = 2.75% + 3% = 5.75%

According to the CAPM,

Required Return = Risk-free Rate + [Beta * Market Risk Premium]

= 5.75% + [1.5 * 6%]

= 5.75 + 9% = 14.75%, or 14.8%

So, Option "D" is correct.