Manufacturing stock has a 10% chance of producing a-50% return, a 20% chance of

Question

Manufacturing stock has a 10% chance of producing a-50% return, a 20% chance of producing a-5% return, a 40% chance of producing a 16% return, a 20% chance of producing a 25% return and a 10% chance of producing a 60% return. What is the firm's expected rate of return? 1. 2. Suppose the risk-free rate is 5% and the market risk premium is 7%, what is the required return on the market? This stock has a required return of 12%. The risk-free rate is 5% and the required return on the market is 10%. a. What is the beta for this stock? b. If this beta were to increase to 2.0, what would be this new required rate of returm? Stock A has a beta of 1.2, Stock B has a beta of 0.6, the required return on the market is 12%, and the risk-free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? 3.

Explanation / Answer

1.Expected rate of return=Respective returns*Respective probabilities

=(0.1*-50)+(0.2*-5)+(0.4*16)+(0.2*25)+(0.1*60)

which is equal to

=11.4%

2.

Market risk premium=Market rate-Risk free rate

Hence Market rate=(5+7)=12%

a.required return= risk-free rate +Beta*(MArket rate- risk-free rate )

12=5+Beta*(10-5)

Beta=(12-5)/5

=1.40

b.Required rate of return=5+2*(10-5)

=15%

3.

Required return for A=7+1.2*(12-7)=13%

Required return for B=7+0.6*(12-7)=10%

Hence excess return=(13-10)=3%

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