Question

Stock r has a beta of 1.5, stock s has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk-free rate is 7%. by how much does the required return on the riskier stock exceed that on the less risky stock? answer

Answer 1

Answer:

4.5%

Explanation:

The formula to compute the expected rate of return under the CAPM model is shown below:

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)      

For stock r, the required rate of return is

= 7% + 1.5× (13% - 7%)

= 7% + 1.5 × 6%

= 16%

For stock s, the required rate of return is

= 7% + 0.75× (13% - 7%)

= 7% + 0.75 × 6%

= 11.5%

So, the difference of required rate of return is

= 16% - 11.5%

= 4.5%

The Stock R has high riskier stock whereas the stock S has less riskier stock due to beta