Question

The current risk free rate of return is 2% and the expected return on the market...

  1. The current risk free rate of return is 2% and the expected return on the market is 6%.
    1. Create a one way data table to determine the cost of equity by varying Beta from 0 to 1.60 in increments of 0.20.
    2. Use your data table to generate a graph. Include a title and label the axes for the graph.
    3. What finance principle does this graph illustrate?

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Answer #1

As per CAPM model,

Cost of equity = Risk free rate + Beta * (Market return - Risk free rate

Beta measures volatility of stock relative to whole market, The above graph illustrates that as the volatility of stock increases investor demands higher returns hence cost of equity also increases.

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