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ompany A has a beta of 0.70, while Company B's beta is 1.05. 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

Respuesta :

Shahzaibfaraz

Answer:

Difference between the required rates of return of A and B = 2.3625%

Explanation:

Using the CAPM, we can calculate the required/expected rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

  • rRF is the risk free rate
  • rM is the market return

r of A = 0.0425 + 0.7 * (0.11 - 0.0425)

r or expected rate of return of A = 0.08975 or 8.975%

r of B = 0.0425 + 1.05 * (0.11 - 0.0425)

r or expected rate of return of B = 0.113375 or 11.3375%

Difference between the required rates of return of A and B = Required rate of return of B - Required rate of return of A

Difference between the required rates of return of A and B = 11.3375% - 8.9750%

Difference between the required rates of return of A and B = 2.3625%

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