If Stock A's beta was 2.0, what would be A's new required rate of return?Assume that the risk-free rate designated by r RF = 5%, the market risk premium designated by r M = 10%, and the expected...

If Stock A's beta was 2.0, what would be A's new required rate of return?

Assume that the risk-free rate designated by r RF = 5%, the market risk premium designated by r M = 10%, and the expected rate of return for stock A is designated by r A = 12%

Asked on by yacel0762

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justaguide | College Teacher | (Level 2) Distinguished Educator

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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.

Stock A has a beta of 2.0. The required rate of return from stock A is higher than that of the return from the market if the market return is positive. The return rA that is related to beta by:

beta = (rA - rF)/(rM - rF)

As rF = 5% and rM = 10% and beta = 2

2 = (rA - 5)/(10 - 5)

10 = rA - 5

=> rA = 15%

The required rate of return from stick A is 15%.

Sources:

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