Question

Stock R has a beta of 2.5, Stock S has a beta of 0.55, the required return on an average stock is 13%, and the risk-free rate of return is 3%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places.

Answer 1

Answer:

19.50%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which 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

= 3% + 2.5 × (13% - 3%)

= 3% + 2.5 × 10%

= 3% + 25%

= 28.00%

For Stock S

= 3% + 0.55 × (13% - 3%)

= 3% + 0.55 × 10%

= 3% + 5.5%

= 8.50%

The difference would be

= 28% - 8.5%

= 19.50%