Question

A stock has a required return of 10%, the risk-free rate is 2.5%, and the market risk premium is 4%.

a) What is the stock's beta? Round your answer to two decimal places.

b) If the market risk premium increased to 8%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged. Do not round intermediate calculations. Round your answer to two decimal places.

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.

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.

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.

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.

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.

c) Stock's required rate of return will be: ?

Answer 1

Where,

Market risk premium = Expected market return - Risk free rate

a) 10% = 2.5% + Beta * 4%

7.5% = Beta * 4%

Beta = 1.875 = 1.88

b) Based on the formula above,

Required return = 2.5% + 1.88 * 8% = 17.5%

Based on this correct statement is Statement "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."

c) Required return = 17.5% (calculated above)