Question

A stock has a required return of 12%, the risk-free rate is 3%, and the market risk premium is 3%.

- What is the stock's beta?
Round your answer to two decimal places.

- If the market risk premium
increased to 10%, 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.
- 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.
- 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 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.
- 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.
- 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.

Answer #1

Part A

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

12 = 3 + ( Beta * 3)

9 = beta * 3

Beta = 3

So, stock beta is 3.

Part b

If Market risk premium is 10%,

Then Required rate of return = 3 + (3 * 10=)

Required of return = 39%

Stock beta is greater than 1. Change in market risk premium is 10%, while change in required rate of return is 27%.

So, If 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.

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