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15 September, 09:35

A stock has a required return of 11%; the risk-free rate is 7%; and the market risk premium is 4%.

a) What is the stock's beta?

b) If the market risk premium increased to 6%, what would happen to the stock's required rate of return? Assume the risk-free rate and the beta remain unchanged

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  1. 15 September, 13:04
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    The Beta is 1

    The required return increases to 13%

    Explanation:

    The formula for required return is given below:

    Required Return = Risk-Free Rate of Return + β (Market Return - Risk-Free Rate of Return)

    required return is 11%

    risk-free rate of return=7%

    Beta is unknown

    market return-risk free rate of return is market risk premium is 4%

    11%=7%+beta (4%)

    11%-7%=beta*4%

    4%=beta*4%

    beta=4%/4%

    beta=1

    If the market risk premium increased to 6%, required return is calculated thus:

    required return=7%+1 (6%)

    required return = 13%

    This implies that the riskier the stock, the higher the market risk premium, the higher the required return to investors.
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