BETA AND REQUIRED RATE OF RETURN A stock has a required return of 11%; the risk-
ID: 2785030 • Letter: B
Question
BETA AND REQUIRED RATE OF RETURN
A stock has a required return of 11%; the risk-free rate is 5.5%; and the market risk premium is 3%.
What is the stock's beta? Round your answer to two decimal places.
If the market risk premium increased to 7%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged.
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.
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.
If 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.
-Select-IIIIIIIVVItem 2
New stock's required rate of return will be %. Round your answer to two decimal places.
Explanation / Answer
a.
Beta is calculated below using CAPM model:
Required rate of return = Risk free rate + (Risk Premium × beta)
11% = 5.50% + (3% × Beta)
Beta = 5.50% / 3%
= 1.83
Beta of company is 1.83.
b.
If the market risk premium increased to 7%, 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..
Option (D) is correct answer.
c.
New stock's required rate of return = 5.50% + (7% × 1.83)
= 5.50% + 12.83%
= 18.33%
New stock's required rate of return will be 18.33%.
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