Question

Assume that the risk-free rate is 4.5% and the required return on the market is 13%. What is the required rate of return on a stock with a beta of 2

Answer 1

Required rate of return= 21.5 %

Step-by-step explanation:

The capital asset pricing model is a risk-based model. Here, the return on equity is dependent on the level of reaction of the the equity to changes in the return on a market portfolio. These changes are captured as systematic risk. The magnitude by which a stock is affected by systematic risk is measured by beta.

Under CAPM, Ke= Rf + β(Rm-Rf)

Rf-risk-free rate, β= Beta, Rm= Return on market.

Using this model,

Ke= 4.5% + 2(13-4.5%)

= 21.5 %

Required rate of return= 21.5 %