Question

Answer the following questions

Suppose that beta for a given stock is the same as market beta. The risk-free rate is 2%.

What is the expected return for this stock if the expected market return is 10%?

What is the expected return for this stock if the market risk premium is 10%?

Answer 1

expected return = risk free rate + (beta * market risk premium).

market risk premium = expected market return - risk free rate.

The market beta is always equal to 1. Therefore the stock beta is 1.

Expected return for this stock if the expected market return is 10%

expected return = risk free rate + (beta * (expected market return - risk free rate))

expected return = 2% + (1 * (10% - 2%)) = 10%.

Expected return for this stock if the market risk premium is 10%

expected return = risk free rate + (beta * market risk premium)

expected return = 2% + (1 * 10%)

expected return = 12%