A stock you are holding has a beta of 2.0 and the stock is currently in equilibr
ID: 2637806 • Letter: A
Question
A stock you are holding has a beta of 2.0 and the stock is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points). The risk-free rate is unchanged. By what percentage (not percentage points) would the required return on your stock increase as a result of this event?A stock you are holding has a beta of 2.0 and the stock is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points). The risk-free rate is unchanged. By what percentage (not percentage points) would the required return on your stock increase as a result of this event?
A stock you are holding has a beta of 2.0 and the stock is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points). The risk-free rate is unchanged. By what percentage (not percentage points) would the required return on your stock increase as a result of this event?
Explanation / Answer
Step 1 Solve for risk-free rate
ks = 15% = kRF + (10% - kRF)2.0 = kRF + 20% - 2kRF
kRF = 5%.
Step 2 Calculate new market return
kM increases by 30%, so kM = 1.3(10%) = 13%.
Step 3 Calculate new required return on stock
ks = 5% + (13% - 5%)2 = 21%.
Step 4 Calculate percentage change in return on stock
. 21% - 15%
. ------------ = 40%.
15%
answer is 40%
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