A stock has a required return of 11 percent; the risk freerate is 7 percent; and

ID: 2661739 • Letter: A

Question

A stock has a required return of 11 percent; the risk freerate is 7 percent; and the market risk premium is 4 percent. a. What is the stock's beta? b. If the market risk premium increased to 6 percent, whatwould happen to the stock's required rate of return? Assumethe risk-free rate and the beta remain unchanged. A stock has a required return of 11 percent; the risk freerate is 7 percent; and the market risk premium is 4 percent. a. What is the stock's beta? b. If the market risk premium increased to 6 percent, whatwould happen to the stock's required rate of return? Assumethe risk-free rate and the beta remain unchanged.

Explanation / Answer

Required Return(RE) 11% Risk-free Rate(Rf) 7% Market Risk premium(MRP) 4% (a) Calculating Stock'sBeta(ß): RE = Rf + ß * MRP 0.11 = 0.07 +ß * 0.04 0.11 - 0.07 = ß * 0.04 ß *0.04 = 0.04 ß = 0.04 /0.04 Stock's Beta(ß) = 1 (b) If theMarket Risk Premium Increased to 6%, the Required Rate of Return onthe Stock will be: Market Risk Premium(MRP) 6% Risk-free Rate(Rf) 7% Stock's Beta (ß) 1 Required Rate of Return(RE)

RE = Rf + ß * MRP RE = 0.07+ 1 * 0.06 RE = 0.07+ 0.06 Required Rate of Return(RE) = 0.13 (or) 13%

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A stock has a required return of 11 percent; the risk freerate is 7 percent; and

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