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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

BETA AND REQUIRED RATE OF RETURN A stock has a required return of 9%, the risk-free rate is 4.5%, and the market risk premium is 3%.

  1. a. What is the stock’s beta?
  2. b. If the market risk premium increased to 5%, what would happen to the stock’s required rate of return? Assume that the risk-free rate and the beta remain unchanged.

a.

Summary Introduction

To determine: The value of stock’s beta.

Portfolio Beta:

The portfolio beta is a measure of the portfolio’s volatility. It measures how the stock moves in the market. A high portfolio shows that securities are more volatile in the price movements while a low beta represents that securities are less volatile in the price movements.

Explanation

Given,

The risk-free rate is 4.5%.

The return on market premium is 3%.

The required return is 9%.

Compute the value of beta.

The formula to calculate the value of beta is,

bstock=(rstockrRF)rM

Where,

  • rstock is the required return on the stock.
  • rRF is the risk-free return.
  • rM is the market risk premium.
  • bstock is the value of the stock’s beta

b.

Summary Introduction

To determine: The required rate of return.

Required Rate of Return:

The required rate of return is the rate which should be the minimum earning on an investment to keep that investment running in the market. When the required return is earned only then the users and the companies invest in that particular investment.

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