Answer:
The required return on the riskier stock (R) exceed the required return on
the less risky stock (S) by = 2.7%
Step-by-step explanation:
Using the CAPM, we can calculate the required 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 * (rM - rRF)
Where,
rRF is the risk free rate
rM is the market return or return on average stock
r of stock R = 0.07 + 1.2 * (0.13 - 0.07)
r of stock R = 14.2%
r of stock S = 0.07 + 0.75 * (0.13 - 0.07)
r of stock S = 11.5%
R is the riskier stock because it has a higher beta than S which is the less riskier stock.
The required return on the riskier stock (R) exceed the required return on
the less risky stock (S) by = 14.2 - 11.5 = 2.7%