Question

g Stock A has a beta of 1.5. Stock B has a beta of 1.2 and an expected return of 12 percent. If the risk-free rate is 2 percent and both stocks have equal reward-to-risk ratios, what is the expected return on stock A

Answer 1

14.5%

Step-by-step explanation:

The computation of the expected return on stock A is shown below:

Given that

The expected return of stock b = 12%

beta = 1.2

Now

risk free rate = 2% market risk premium

So as per CAPM, the expected return = risk free rate + beta × market risk premium

0.12 = 0.02 + 1.2 × market risk premium

1.2 × market risk premium = 0.10

So,

market risk premium is

= 0.10 ÷ 1.2

= 0.0833 or 8.33%

Since they have equal risk reward so the market risk premium would be same for stock A

Now

The expected return of stock A is

= 2% + (1.5 × 8.33)

= 14.5%