Question

The beta of Stock A is –0.4 (indicating that its returns rise when returns on most other stocks fall). If the risk-free rate is 4.5 percent and the expected rate of return on an average stock is 8.3 percent, what is the required rate of return on Stock A?

Answer 1

Answer:

=2.98%

Explanation:

Use CAPM to find the required return of the stock;

CAPM: r = risk free + beta(market return - risk free)

risk free = 4.5% or 0.045 as a decimal

beta = -0.4

market return = 8.3% or 0.083 as a decimal

Next, plug in the numbers into the CAPM formula;

r = 0.045 -0.4(0.083 - 0.045)

r = 0.045 -0.0152

r = 0.0298 or 2.98%

Therefore the required return is 2.98%