Question

Required rate of return Stock R has a beta of 1.6, Stock S has a beta of 0.55, the required return on an average stock is 8%, and the risk-free rate of return is 5%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places. %

Answer 1

The required return on the riskier stock exceeds the required return on the less risky stock by 6.15%.

Step-by-step explanation:

The required return on a riskier stock can be calculated using the Capital Asset Pricing Model (CAPM). CAPM is a financial model that determines an expected return based on the risk-free rate of return, the beta of the stock, and the market risk premium. The formula for CAPM is:

Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

Using the given information, we can calculate the required return for each stock:

Stock R: Required Return = 5% + 1.6 * (8% - 5%) = 12.8%

Stock S: Required Return = 5% + 0.55 * (8% - 5%) = 6.65%

The required return on the riskier stock (Stock R) exceeds the required return on the less risky stock (Stock S) by:

12.8% - 6.65% = 6.15%