The common stock of Jensen Shipping has a risk premium of 11.00 percent. What is

Question

The common stock of Jensen Shipping has a risk premium of 11.00 percent. What is the market risk-premium if the company's beta is 1.0? What is expected return on the market if the risk-free return is 2.00 percent?

a) Risk premium is 11.50 percent; Market expected return is 9.50 percent
b) Risk premium is 10.70 percent; Market expected return is 8.70 percent
c) Risk premium is 11.00 percent; Market expected return is 13.00 percent
d) Risk premium is 11.75 percent; Market expected return is 9.75 percent
e) Risk premium is 11.00 percent; Market expected return is 13.00 percent

Please Show all the steps to solve this.

Explanation / Answer

Risk Premium=Beta(Market Risk-Risk free return)

0.11=1.0(Market Risk-.02)

Market Risk =0.13 or 13%

Market Risk Premium=Market Risk-Risk Free Return

Market Risk Premium=0.13-0.02=0.11 or 11%

Expected Return=Risk Free Rate+Beta(Market Risk-Risk free return)

                             =0.02+1.0(0.13-0.02)

                             =13%

Answer is par C i.e. Risk premium is 11.00 percent and Market Expected Return is 13.00%

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