Question

Stock R has a beta of 2.0, Stock S has a beta of 0.95, the required return on an average stock is 13%, and the risk-free rate of return is 5%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places.

%

Answer 1

Beta of Stock R = 2.0

Beta of Stock S = 0.95

The higher the Beta the more risker it is. Thus, Stock R is more risker as having higher Beta

As per CAPM,

where, rf = Risk free return = 5%

Rm = Market Return or average stock return = 13%

- Beta of Stock R = 2.0

Required Return of Stock R = 5% + 2.0(13%-5%)

Required Return of Stock R = 21%

- - Beta of Stock S = 0.95

Required Return of Stock S = 5% + 0.95(13%-5%)

Required Return of Stock S = 12.60%

So, the required return on the riskier stock exceed the required return on the less risky stock = Required Return of Stock R - Required Return of Stock S

= 21% - 12.60%

= 8.4%

Thus, Required Return of Risker Stock exceed less risky stock by 8.40%

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