Question

Assume that the risk-free rate is 6% and the required return on the market is 12%. What is the required rate of return on a stock with a beta of 1? Round your answer to two decimal places.

Answer 1

Required Rate of Return on Stock:

Subtract the risk-free rate of return from the market rate of return. Take that result and multiply it by the beta of the security. Add the result to the current risk-free rate of return to determine the required rate of return.

This can be written as following formula under Capital Asset Pricing Model (CAPM) Approach:

Ri ​= Rf ​+ β ​( Rm​ −Rf ​)

Where,

Ri​ = Required return of investment

Rf​ = Risk-Free rate

β ​= Beta of the investment

(Rm ​− Rf​) = Market risk premium

In the given problem, Risk Free Rate is R_f is = 6%

Required return on market is R_m is = 12%

Beta (β) is = 1

Therefore, Required Return on Stock is = 6% + 1 (12% - 6%) = 12% or 0.12