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Homework answers / question archive / The risk-free rate is 3% and the market risk portfolio is 8%
The risk-free rate is 3% and the market risk portfolio is 8%. Stock A has beta of 1.2 while stock B has a beta of 0.8. i) Calculate the value required rate of return on each stock. ii) Assume that investors become less willingness to take on risk, so the market risk portfolio rises from eight percent to ten percent. Assume that the risk- free rate remains constant. Find the new required rate of return on the two stocks. ii) Briefly explain why the changes happen. b) Briefly explain the following terms: i) Systematic risk Unsystematic risk Single asset iv) Portfolio investment
a. Required rate of return=risk free rate+(beta*(market return-risk free rate))
Required rate of return of Stock A=3%+(1.2*8%)=12.6%
Required rate of return Stock B=3%+(0.8*8%)=9.4%
==> if market risk premium rises to 10%, then
Required rate of return of Stock A=3%+(1.2*10%)=15%
Required rate of return Stock B=3%+(0.8*10%)=11%
==> its because of higher rsik premium, the investors demand more return for its which leads to increase in the required rate of return.
b. Systematic risk is the risk which can't be mitigated and affects the overall market, not just a particular stock or industry. Eaxmples include macroeconomic factors such as inflation, changes in interest rates, fluctuations in currencies, recessions, wars, etc.
Unsystematic risk is the risk that can be mitigated with better diversification of asset class in a portfolio.
Single asset is an asset which will have high standard dveiation which means high risk.
Portfolio investments are investments in the form of a group of assets, in equity, securities, such as common stock, and debt securities, such as banknotes, bonds, and debentures. This mitigates the risk to a greater extent.
