Question

1. You are considering buying a stock with a beta of 3.10. If the risk-free rate of return is 6.0%, and the expected return for the market is 10.0%, what should the expected rate of return be for this stock?

2. You are holding a stock that has a beta of 2.63 and is currently in equilibrium. The required return on the stock is 39.40% and the return on a risk-free asset is 8.0%. What would be the return on the stock if the stock's beta increased to 3.66 while the risk-free rate and market return remained unchanged?

Answer 1

1) Using CAPM,

Expected Return on stock = Risk free rate + Beta *(Market Return - Risk free rate)

= 6 + 3.10 * (10 - 6)

Expected Return on stock = 18.4% Answer

2) Using CAPM,

Required Return = Risk free rate + Beta * (Market Return - Risk free)

39.4 = 8 + 2.63 * (Market Return - 8)

Market Return = 11.939 + 8 = 19.939 %

Beta increased to 3.66

Return On the stock = 8 + 3.66 * (19.939 - 8) = 51.70 % Answer

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