Assume that the risk-free rate is 6% and the expected return on the market is 13%. What is the required rate of return on a stock that has a beta of 0.7%?
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The beta of a stock gives the volatility of returns of the stock compared to the returns of the benchmark used to estimate volatility. Stocks with a high value of beta are high-risk, high-return options; compared to the benchmark they give higher gains as well as higher losses. Low beta stocks are less volatile with their returns but they have a lower magnitude as compared to the benchmark.
The relation between the beta of a stock B, the risk-free rate of return rF, the return from the market rM and the return that the stock gives R is : B = (R - rF)/(rM - rF)
Here, the risk free rate is 6%, the expected rate of return from the market is 13% and the beta of the stock is 0.7
0.7 = (R - 6)/(13 - 6)
=> R - 6 = 4.9
=> R = 10.9
The required rate of return from the stock is 10.9%
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