Question

1. Assume the expected return on the market is 5 percent and the risk-free rate is 4 percent.

- What is the expected return for a stock with a beta equal to 1.00? (Round answers to 2 decimal places, e.g. 15.25.)

Expected return

2. Assume the expected return on the market is 8 percent and the risk-free rate is 4 percent.

- What is the expected return for a stock with a beta equal to 1.50? (Round answers to 2 decimal places, e.g. 15.25.)

Expected return

- What is the market risk premium?

Market risk premium

Answer 1

Q 1). Solution :-

Expected return for stock = Risk free return + Beta of stock * (Expected Return on market - Risk free return)

= 4 % + 1.00 * (5 % - 4 %)

= 4 % + 1.00 * 1 %

= 4 % + 1.00 %

= 5.00 %

Conclusion :- Expected return for stock = 5.00 %.

Q. 2) Solution :-

Expected return for stock = Risk free return + Beta of stock * (Expected Return on market - Risk free return)

= 4 % + 1.50 * (8 % - 4 %)

= 4 % + 1.50 * 4 %

= 4 % + 6.00 %

= 10.00 %

Market risk premium = Expected Return on market - Risk free return.

= 8 % - 4 %

= 4 %

Conclsuion :-

Q. 2). a). Expected return for stock	10.00 %
Q. 2). b). Market risk premium	4.00 %

(The difference between expected return on market and risk free return is generally referred to as Market risk premium).