Question

6. Suppose the Treasury Bill risk-free rate = 9%, Stock Market return =14%, and Antivirus Inc.’s stock beta = 1.3 a. What is the required return on Maxwell stock? b. If the expected inflation rate (Inflation Premium) increased by 1%, what is the effect on the Treasury Bill risk-free rate, Stock Market return, and required return on Maxwell stock c. Assume that the current trade war increases Market Risk Premium by 1%, what is the effect on the required return on Antivirus stock.

Answer 1

(a)

According Security market line (SML)

Required Return = Risk-Free Rate of Return + Beta (Market Return - Risk-Free Rate of Return)

Required Return = 9% + (14%-9%) x 1.30

Required Return = 9%+6.5%= 15.50%

(b)

If expected inflation rate increased by 1%.

Treasury Bill risk-free rate is also increased by 1%. = 9%+ 1% =10%

Stock Market return  is also increased by 1%. = 14%+ 1% =15%

Required Return = Risk-Free Rate of Return + Beta (Market Return - Risk-Free Rate of Return)

Required Return = 10% + (15%-10%) x 1.30

Required Return = 10%+6.5%= 16.50%

(c)

Required Return = Risk-Free Rate of Return + Beta (Market Return - Risk-Free Rate of Return)

Required Return = 10% + (5%+1%) x 1.30

Required Return = 10%+7.8%= 17.80%