Final answer:
The required return for the overall stock market with a risk-free rate of 2.5% and a market risk premium of 5% is 7.5%. For a stock with a beta of 0.6, the required rate of return is 5.5%. These calculations are based on the Capital Asset Pricing Model.
Step-by-step explanation:
Assuming the risk-free rate is 2.5% and the market risk premium is 5%, the required return for the overall stock market is the sum of these two figures, which amounts to 7.5%. This calculation is based on the Capital Asset Pricing Model (CAPM), which is used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.
To find the required rate of return on a stock with a beta of 0.6, we use the formula:
Required Return = Risk-Free Rate + (Beta x Market Risk Premium)
Therefore, the required return on this stock would be:
Required Return = 2.5% + (0.6 x 5%) = 2.5% + 3% = 5.5%
The required return for a stock with a beta of 0.6 is thus 5.5%, which reflects both the time value of money and the risk associated with the stock.