Question

Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return?

Answer 1

Answer:

The difference between A and B Required Rate of Return is 3.38%

Explanation:

As we know that required rate of return we use CAPM formula that is

Required rate of return = Rf + (Rm - Rf) x Beta

Stock A Return = 4.25% + (11% - 4.25% )  x 0.70

Stock A return = 8.98%

Stock B Return = 4.25% + (11% - 4.25%) x 1.20

Stock B Return = 12.35%

Difference between Return = Stock B Return - Stock A Return

Difference between Return = 12.35% - 8.98%

Difference between Return = 3.38%

Answer 2

The difference between A's and B's required rates of return is E. 3.38%

Explanation:

Company A has a beta of 0.70, while Company B's beta is 1.20.  The required return on the stock market is 11.00%, and the risk-free rate is 4.25%.  What is the difference between A's and B's required rates of return?  (Hint: First find the market risk premium, then find the required returns on the stocks.)

a..2.75%

b. 2.89%

c. 3.05%

d. 3.21%

E. 3.38%

The Capital Asset Pricing Model (CAPM) is the relationship between systematic risk and expected return for assets, and particularly stocks. CAPM is widely used to pricing risky securities throughout finance and generating expected returns for assets given the risk of those assets and cost of capital.

Company A has a beta of 0.70

Company B's beta is 1.20.  

The required return on the stock market is 11.00%,

The risk-free rate is 4.25%.  

Therefore Risk Premium is: 11% - 4.25% = 6.75%.

Feed into the CAPM and you can find the returns of  8.975% for A and 12.35% for B

A rate of return is the net gain or loss on an investment over a specified time period.  A rate of return is expressed as a percentage of the investment's initial cost.

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