A stock's beta is 1.5. The risk-free rate of interest is 2% and you expect the return on the stock market to be 7%.

a) What rate of return should you require if interest rates rise, so that the risk-free rate of interest becomes 4%? (Assume that the market risk premium, the difference between the market return and the risk-free rate (r_M – r_F ) is still 5%; in other words, the expected market return increases to 9%.)

b) What rate of return should you require if interest rates don’t change (i.e., the risk-free rate is still 2%), but you think the stock market will return 10%? (In other words, the market risk premium increases.)

Answer rating: 100% (QA)

1 General expected rate of return Risk free rate BetaReturn on marketRisk free rate 21572 95 a Requi... View the full answer