Question

Assume that the risk-free rate is 6% and the market risk premium is 8%.

What is the expected return for the overall stock market? Round your answer to two decimal places.
___________ %

What is the required rate of return on a stock with a beta of 1.9? Round your answer to two decimal places.
___________ %

Answer 1

The expected return for the overall stock market is 12% and the required rate of return on a stock with a beta of 1.9 is 21.2%.

Step-by-step explanation:

The expected return for the overall stock market can be calculated by adding the risk-free rate to the product of the market risk premium and the expected return on the market. In this case, the risk-free rate is 6% and the market risk premium is 8%. So, the expected return for the overall stock market is 6% + (8% × 6%) = 12%.

The required rate of return on a stock with a beta of 1.9 can be calculated by multiplying the stock's beta with the market risk premium and adding it to the risk-free rate. In this case, the beta is 1.9, the market risk premium is 8%, and the risk-free rate is 6%. So, the required rate of return on the stock is 6% + (8% × 1.9) = 21.2%.

Answer 2

r or expected rate of return - market = 0.14 or 14%

r or expected rate of return - stock = 0.2120 or 21.20%

Step-by-step explanation:

Using the CAPM, we can calculate the required/expected rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * rpM

Where,

• rRF is the risk free rate

• rpM is the market risk premium

Under CAPM, the assumption follows that the beta of the market is always equal to 1.

So, expected return on the stock market will be,

r or expected rate of return - market = 0.06 + 1 * 0.08

r or expected rate of return - market = 0.14 or 14%

The beta of the stock is given. We calculate the required rate of return on the stock to be,

r or expected rate of return - stock = 0.06 + 1.9 * 0.08

r or expected rate of return - stock = 0.2120 or 21.20%