Question

Stock A's stock has a beta of 1.30, and its required return is 14.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Select the correct answer.

a. 10.28%

b. 10.32%

c. 10.44%

d. 10.36%

e. 10.40%

Answer 1

According to the CAPM equation:
Required return=Risk free rate +Beta*(Market risk premium)

For stock A:
14%=4.75% +1.30*(Market risk premium)
=>14%-4.75%=1.30*(Market risk premium)
=>9.25%=1.30*(Market risk premium)
=>9.25%/1.30=(Market risk premium)
=>Market risk premium=0.071153846

For stock B:
Required return =4.75% +0.80*(Market risk premium)
Now, substituting the values for market risk premium, we get;
Required return =4.75% +0.80*(0.071153846)
=4.75% +0.056923077
=0.104423077 or 10.44% (Rounded to 2 decimal places)

Answer: 10.44%