Question

If the market risk premium increased to 5%, what would happen to the stock's required rate of return

Answer 1

Answer:

a. 1.5

b. Required rate of return would increase by 3% to 12%

Explanation:

a. According to the Capital Asset Pricing Model,

Required return = Risk free rate + beta *market premium

9% = 4.5% + beta * 3%

Beta * 3% = 9% - 4.5%

Beta = (9% - 4.5%)/3%

= 1.5

b.

= 4.5% + 1.5 * 5%

= 12%

The required return would increase by 3%