Stock R has a beta of 2.0, Stock S has a beta of 0.35, the required return on an average stock is 9%, and the risk-free rate of return is 3%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places. %
Stock R has a beta of 2.0, Stock S has a beta of 0.35, the required return on an average stock is 9%, and the risk-free rate of return is 3%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places. %
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
![**Problem Statement:**
Stock R has a beta of 2.0, Stock S has a beta of 0.35, the required return on an average stock is 9%, and the risk-free rate of return is 3%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places.
**Solution Explanation:**
To calculate the required return on each stock, we use the Capital Asset Pricing Model (CAPM), which is given by the formula:
\[ \text{Required Return} = \text{Risk-free Rate} + \beta \times (\text{Market Return} - \text{Risk-free Rate}) \]
**For Stock R:**
- Beta (\(\beta_R\)) = 2.0
- Risk-free Rate = 3%
- Market Return = 9%
- Required Return for Stock R = \(3\% + 2.0 \times (9\% - 3\%) = 3\% + 2.0 \times 6\% = 3\% + 12\% = 15\%\)
**For Stock S:**
- Beta (\(\beta_S\)) = 0.35
- Risk-free Rate = 3%
- Market Return = 9%
- Required Return for Stock S = \(3\% + 0.35 \times (9\% - 3\%) = 3\% + 0.35 \times 6\% = 3\% + 2.1\% = 5.1\%\)
**Difference in Required Returns:**
The difference in the required return between the riskier stock (Stock R) and the less risky stock (Stock S) is:
\[ 15\% - 5.1\% = 9.9\% \]
Thus, the required return on the riskier stock exceeds the required return on the less risky stock by **9.9%**.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F00e39c23-5382-4320-a2d9-cf042c74097f%2Fcfab0816-d83f-4772-af8c-188a04fc95bb%2Fzyoro2_processed.png&w=3840&q=75)
Transcribed Image Text:**Problem Statement:**
Stock R has a beta of 2.0, Stock S has a beta of 0.35, the required return on an average stock is 9%, and the risk-free rate of return is 3%. By how much does the required return on the riskier stock exceed the required return on the less risky stock? Round your answer to two decimal places.
**Solution Explanation:**
To calculate the required return on each stock, we use the Capital Asset Pricing Model (CAPM), which is given by the formula:
\[ \text{Required Return} = \text{Risk-free Rate} + \beta \times (\text{Market Return} - \text{Risk-free Rate}) \]
**For Stock R:**
- Beta (\(\beta_R\)) = 2.0
- Risk-free Rate = 3%
- Market Return = 9%
- Required Return for Stock R = \(3\% + 2.0 \times (9\% - 3\%) = 3\% + 2.0 \times 6\% = 3\% + 12\% = 15\%\)
**For Stock S:**
- Beta (\(\beta_S\)) = 0.35
- Risk-free Rate = 3%
- Market Return = 9%
- Required Return for Stock S = \(3\% + 0.35 \times (9\% - 3\%) = 3\% + 0.35 \times 6\% = 3\% + 2.1\% = 5.1\%\)
**Difference in Required Returns:**
The difference in the required return between the riskier stock (Stock R) and the less risky stock (Stock S) is:
\[ 15\% - 5.1\% = 9.9\% \]
Thus, the required return on the riskier stock exceeds the required return on the less risky stock by **9.9%**.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education