Question

with a risk-free rate of 2.4% and a market risk-premium of 8.3%, a stock's expected rate of return is 11.3%. the following year, the market risk premium decreases by 1% but the stock's beta and the risk free rate remain the same. what will be the expected rate of return on the stock for that year

Answer 1

Solution ;-

First we need to Calculate Beta-

As per Capital Asset pricing Model-

Expected Return = Risk free Return + Beta * Market Risk Premium.

0.113 = 0.024 + Beta * 0.083

0.113 - 0.024 = Beta * 0.083

Beta = 0.089 / 0.083

Beta = 1.07

To Calculate Expected Return of stock -

New Market Risk Premium = 8.30% - 1% = 7.30%

Expected Return = Risk Free Return + Beta * New market Risk Premium

Expected Return = 0.024 + 1.07 * 0.073

Expected Return = 10.23%.

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