Question

Company A has a beta of 0.70, while Company B's beta is 0.80. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

Answer 1

Answer:

the differene in the required rate of return of eahc company is 0.675%

Explanation:

we solve using the CAPM method:

$Ke= r_f + \beta (r_m-r_f)$  

risk free 0.0425

market rate 0.11

Company A

beta(non diversifiable risk) 0.7  

$Ke= 0.0425 + 0.7 (0.0675)$  

Ke 0.08975 = 8.975%

Company B

beta(non diversifiable risk) 0.8

$Ke= 0.0425 + 0.8 (0.0675)$

Ke 0.09650 = 9.65%

difference: 9.65% - 8.975% =  0.675%