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You are holding a stock which is currently in equilibrium
You are holding a stock which is currently in equilibrium. The required rate of return on the stock is 15 percent when the required return on an average stock is 10 percent. What will be the percentage change in the required return on the stock if the required return on an average stock increases by 30 percent while the risk-free rate is unchanged? Your stock has a beta of 2.
Expert Solution
By CAPM, Required rate of return is
Rr = Rf + Beta * (Rm-Rf)
Rf = risk free rate
Rm = Market average return rate
then:
15% = Rf + 2 * (10%-Rf)
15% = Rf + 20% - 2Rf
Rf = 5%
When Rm increased by 30%, Rm = 10%*(1+30%) = 13%
Then Rr = Rf + Beta * (Rm-Rf)
Rr = 5% + 2*(13% - 5%) = 21%
Then the percentage change is (21%-15%)/15% = 6% / 15% = 0.4 = 40%.
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