Question

Beta and required rate of return

A stock has a required return of 11%; the risk-free rate is 7%; 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 9%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged.
   1. 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.
   2. 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.
   3. 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.
   4. 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.
   5. 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.
   
   -Select-IIIIIIIVVItem 2
   
   New stock's required rate of return will be  %. Round your answer to two decimal places.

Answer 1

a]

required return = risk free rate + (beta * market risk premium)

11% = 7% + (beta * 3%)

beta = 1.33

b]

As we can see from the formula, the change in required return would be dependent on beta. If the beta is greater than 1.0, then the change in required return would be greater than the change in market risk premium. If the beta is less than 1.0, then the change in required return would be less than the change in market risk premium.

The answer is I -  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.

new required rate of return = risk free rate + (beta * market risk premium)

new required rate of return = 7% + (1.33 * 9%) = 18.97%