Question

Stock R has a beta of 1.4, Stock S has a beta of 0.55, the expected rate of return on an average stock is 12%, 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.

Answer 1

Market Return = 12.00%
Risk-free Rate = 4.00%

Stock R:

Required Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Required Return = 4.00% + 1.40 * (12.00% - 4.00%)
Required Return = 4.00% + 1.40 * 8.00%
Required Return = 15.20%

Stock S:

Required Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Required Return = 4.00% + 0.55 * (12.00% - 4.00%)
Required Return = 4.00% + 0.55 * 8.00%
Required Return = 8.40%

Difference in Required Return = Required Return of Stock R - Required Return of Stock S
Difference in Required Return = 15.20% - 8.40%
Difference in Required Return = 6.80%

Therefore, required return on riskier stock exceed that on the less risky stock by 6.80%