Chapter 8, Problem 18PROB

Summary Introduction

Portfolio beta is used to measure the portfolio’s overall systematic risk of an investment which equals the weighted average of all individual stock’s beta coefficient in a portfolio.

Capital asset pricing model (CAPM) is one of the methods used to calculate the cost of equity which show the relationship between expected return and risk of an investment. It describes that the expected return of the security is equal to the sum of rate of return of an investment and risk premium.

$r=r_{RF}+\beta \times R{P}_M$

Here,

The cost of equity or required rate of return is “r”.

The risk-free rate is “$r_{RF}$”.

The risk premium is “$R{P}_M$” which is calculated as $\left(r_M-r_{RF}\right)$.

The market return is “$r_M$”.

The beta coefficient is “$\beta$”.

The required rate of return of stock Q is 11%, risk-free rate is 4%, and market return is 9%. As per new information, the market risk premium increase by 1%.