Question

A stock has a required return of 14%, the risk-free rate is 7.5%, and the market risk premium is 3%.

1. What is the stock's beta? Round your answer to two decimal places.
2. If the market risk premium increased to 6%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged. Do not round intermediate calculations. Round your answer to two decimal places.
   1. If the stock's beta is less than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   2. If the stock's beta is greater than 1.0, then the change in required rate of return will be less than the change in the market risk premium.
   3. If the stock's beta is equal to 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   4. If the stock's beta is equal to 1.0, then the change in required rate of return will be less than the change in the market risk premium.
   5. If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.

   -Select-IIIIIIIVVItem 2

   Stock's required rate of return will be   %.

Answer 1

As per CAPM,

where, rf = Risk free return = 7.5%

Rmp = Market Risk Premium = 3%

Required rate of Return = 14%

Calculating Beta:-

14% = 7.5% +Beta(3%)

Beta = 2.17

b). If the market risk premium increased to 6% and the risk-free rate and the beta remain unchanged

where, rf = Risk free return = 7.5%

Rmp = Market Risk Premium = 6%

Beta = 2.17

Required rate of Return = 7.5% + 2.17(6%)

Required rate of Return = 20.50%

- Ans. Option 5 If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.

If you need any clarification, you can ask in comments.    

If you like my answer, then please up-vote as it will be motivating