Assume that the risk-free rate is 2%, the market risk premium is 5%, and the beta of

Question:

Assume that the risk-free rate is 2%, the market risk premium is 5%, and the beta of two stocks A and Bare 1.4 and 0.8, respectively.

a. Calculate both stocks' required rates of return.

b. What would be the return on an "average" stock?

c. Explain the significance of a security with a 0 beta. What would be this security's required return?

d. Assume that the economy worsens and that investors correspondingly revise their attitudes toward stocks. Would this change be better reflected in a shift in the market risk premium to 3.5% or 6.5%?

e. Based on your answer to (d), what would be the new required return for stocks A and B? Would you expect stock prices for A and B to fall or rise?

f. Ignoring (d) and (e) above, assume that inflationary expectations were revised upward by 0.5%. What would be the change to required returns for stocks A and B? Would their prices fall or rise?

Stocks
Stocks or shares are generally equity instruments that provide the largest source of raising funds in any public or private listed company's. The instruments are issued on a stock exchange from where a large number of general public who are willing...

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