Question

Beta and required rate of return

A stock has a required return of 13%; the risk-free rate is 3%; and the market risk premium is 3%.

1. What is the stock's beta? Round your answer to two decimal places.
   
   
2. If the market risk premium increased to 10%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged.
   1. If the stock's beta is equal to 1.0, then the change in required rate of return will be less than the change in the market risk premium.
   2. If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   3. If the stock's beta is less than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   4. If the stock's beta is greater than 1.0, then the change in required rate of return will be less than the change in the market risk premium.
   5. If the stock's beta is equal to 1.0, then the change in required rate of return will be greater than the change in the market risk premium.
   
   
   New stock's required rate of return will be __ %. Round your answer to two decimal places.

Answer 1

a.

Using CAPM model,

0.13 = 0.03 + Beta(0.03)

Beta = 3.33

b.

If the stock's beta is greater than 1.0, then the change in required rate of return will be greater than the change in the market risk premium.

c.

New Required Return = 0.03 + 3.33(0.10)

New Required Return = 36.30%