Question

Instructions: You are required to use a financial calculator or spreadsheet (Excel) to solve the problems (provided on page 4) related to risk and return characteristics and stock/bond valuation. You are required to show the following three steps for each problem (sample problems and solutions are provided for guidance):

(i) Describe and interpret the assumptions related to the problem.

(ii) Apply the appropriate mathematical model to solve the problem.

(iii) Calculate the correct solution to the problem.

The market return, based on a broad market index, is estimated to be 15%. Calculate Company ABC’s required return if the risk-free rate is 4% and the stock’s beta is 1.35 (round your answer to two decimal places).

Answer 1

Assumption related to problems are

risk free rate with zero degree of risk is = 4% which is constant

Market index based return is = 15% which is constant

beta of stock = sensitivity of security return to market return is 1.35

2- Model used to solve the problem is capital asset pricing model

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

3-

required rate of return

risk free rate +(market return-risk free rate)*beta

4+(15-4)*1.35

18.85