Question

A stock has a required return of 11%; the risk-free rate is 7%; and the market risk premium is 4%.

a) What is the stock's beta?

b) If the market risk premium increased to 6%, what would happen to the stock's required rate of return? Assume the risk-free rate and the beta remain unchanged

Answer 1

The Beta is 1

The required return increases to 13%

Step-by-step explanation:

The formula for required return is given below:

Required Return = Risk-Free Rate of Return + β(Market Return – Risk-Free Rate of Return)

required return is 11%

risk-free rate of return=7%

Beta is unknown

market return-risk free rate of return is market risk premium is 4%

11%=7%+beta(4%)

11%-7%=beta*4%

4%=beta*4%

beta=4%/4%

beta=1

If the market risk premium increased to 6%,required return is calculated thus:

required return=7%+1(6%)

required return =13%

This implies that the riskier the stock, the higher the market risk premium, the higher the required return to investors.