Question

5. Suppose risk-free rate of return = 2%, market return = 7%, and Stock B's return = 11%. a. Calcuate Stock B’s beta. b. If Stock B’s beta were 0.80, what would be its new rate of return?

Answer 1

Risk-free rate = R_F = 2%

Market return = R_M = 7%

Stock B return = R_B = 11%

CAPM Equation:

R_B = R_F+β_B*(R_M-R_F)

Part a

Beta of stock B = β_B

Beta of stock B can be calculated using CAPM

11% = 2% + β_B*(7%-2%)

9% = β_B*5%

β_B = 9%/5% = 1.8

Beta of stock B = 1.8

Answer a -> 1.8

Part b

Beta of stock B = β_B = 0.8

New rate of return can be calculated using CAPM

Rate of return = R_B = 2% + 0.8*(7% - 2%) = 2% + 0.8*5% = 2%+4% = 6%

Answer b -> 6%