If Stock A has a beta of 1.2 and a standard deviation of returns of 18% and Stoc
ID: 2666614 • Letter: I
Question
If Stock A has a beta of 1.2 and a standard deviation of returns of 18% and Stock B has a beta of 1.8 and a standard deviation of returns of 18% and the market risk premium increases, what will happen to each of the stocks required rates of return? Will one go up more than the other? Will they stay the same? Why?Explanation / Answer
Required rate, r(m) = risk free rate, r(f) + beta, b * risk premium, r(p) => r(m) = r(f) + b*r(p) So, if r(p) increases, r(m) will increase 1.2 times r(p) increase and mostly within sd of 18% for stock A . And r(m) will increase 1.8 times increase of r(p) and may cross 18% sd for stock B . Hence, r(m) will go up more in case of stock B. (ANSWER)