Question

1. The stock market is expected to generate an 11% return and the standard deviation of market returns is 15%. Nelson Hydro Products are currently 20% more volatile than the market. If the risk-free rate of return is 4%, what is the required rate of return for investors in Nelson Hydro?

Answer 1

We know that the beta of a stock measures its volatility with respect to the market. It is given that Nelson Hydro products are currently 20% more volatile than the market hence, its beta is 1.2 [β_i = 1.2]

where β_i is the beta of the investment i.e., Nelson Hydro Products

The following data is given:-

Expected return on market = E[R_M] = 11%

Risk free rate of return = R_f  = 4%

Using the CAPM Equation

E[R_i]= R_f + β_i * (E[R_M]- R_f ) = 4% + 1.2 * (11% - 4%) = 12.4%

Answer -> 12.4%