Investors expect the market rate of return this year to be 14.00%. The expected

Question

Investors expect the market rate of return this year to be 14.00%. The expected rate of return on a stock with a beta of 1.8 is currently 25.20%. If the market return this year turns out to be 12.70%, how would you revise your expectation of the rate of return on the stock?

Investors expect the market rate of return this year to be 14.00%. The expected rate of return on a stock with a beta of 1.8 is currently 25.20%. If the market return this year turns out to be 12.70%, how would you revise your expectation of the rate of return on the stock?

Explanation / Answer

The expected return on the stock would be your beta (1.8) times the market return or:

1.8 * 12.70% = 22.86%

Likewise, you could also determine how much the return would decrease by multiplying the beta times the change in the market return or:

1.8 * (12.70%-14%) = -2.34% + 25.20% = 22.86%

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