You have been provided the following information as part of a consultation query: The risk free rate is 3.2% The market risk premium (rM - rRF) is 5.3% Stock A - has a beta of 1.2 beta Stock B - has a beta of 0.85 beta (a). What is the required rate of return on each stock? (b). Assume that investors become less willing to take on risk (ie., they become more riskaverse), so the market risk premium rises 6%. Assume that the risk-free rate remains constant. What effect will this have on the required rates of return on the two stocks?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
You have been provided the following information as part of a consultation query:
The risk free rate is 3.2%
The market risk premium (rM - rRF) is 5.3%
Stock A - has a beta of 1.2 beta
Stock B - has a beta of 0.85 beta
(a). What is the required rate of return on each stock?
(b). Assume that investors become less willing to take on risk (ie., they become more riskaverse), so the market risk premium rises 6%. Assume that the risk-free rate remains constant. What effect will this have on the required
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