Question

Stock R has a beta of 1.5, Stock S has a beta of 0.85, the expected...

Stock R has a beta of 1.5, Stock S has a beta of 0.85, the expected rate of return on an average stock is 13%, and the risk-free rate is 4%. By how much does the required return on the riskier stock exceed that on the less risky stock? Do not round intermediate calculations. Round your answer to two decimal places.

Homework Answers

Answer #1

Required rate of return of stock R

The required return on stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke= Rf+b[E(Rm)-Rf]

where:

Rf= risk-free rate of return

Rm= expected rate of return on the market.

Rm-Rf= Market risk premium

b= Stock’s beta

Ke = 4% + 1.5*(13% - 4%)

= 4% + 13.50%

= 17.50%

Required rate of return of stock S

The required return on stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke= Rf+b[E(Rm)-Rf]

where:

Rf= risk-free rate of return

Rm= expected rate of return on the market.

Rm-Rf= Market risk premium

b= Stock’s beta

Ke = 4% + 0.85*(13% - 4%)

= 4% + 7.65%

= 11.65%

Difference between the required return of both the stock:

= 17.50% - 11.65%

= 5.85%.

In case of any further queries, kindly comment on the solution.

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