A stock has a required return of 14%, the risk-free rate is 3%, and the market risk premium is 6%.
a) Based on CAPM,
Required Return = Risk free rate + Beta * Market risk premium
14% = 3% + Beta * 6%
11% = Beta * 6%
Beta = 1.83
b) Based on the CAPM equation above, required return is directly related to market risk premium and is influenced by the beta. Higher the beta, higher would be the change in required return on change in market risk premium.
So, correct statement is: 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) Required Return = 3% + 1.83 * 8%
Required return = 17.67%
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