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Assume that the risk-free rate is 6% and the expected return on the market is 13%. What...

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yacel0762 | Valedictorian

Posted July 20, 2012 at 3:10 AM via web

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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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justaguide | College Teacher | (Level 2) Distinguished Educator

Posted July 20, 2012 at 3:35 AM (Answer #1)

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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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