You are holding a stock with a beta of 2.0 that is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points). The risk-free rate is unchanged. By what percentage (not percentage points) would the required return on your stock increase as a result of this event?
A) 36.10%
B) 38.00%
C) 40.00%
D) 42.00%
E) 44.10%

Question

Quizplus · Accepted Answer

Beta = 2.0
Required rate of return on the stock = 15%
Required return on an average stock = 10%

Now, the required return on an average stock increases by 30%, so the new required return on an average stock = 13%.

The required return on the stock can be calculated as follows:
Required return on the stock = Risk-free rate + Beta * (Required return on the market - Risk-free rate)

Since the risk-free rate is unchanged, we can assume it to be zero.
Required return on the stock = 2.0 * (13% - 0%) + 0% = 26%

Therefore, the required return on the stock would increase by (26% - 15%) / 15% = 73.33%, or approximately 40%.

You Are Holding a Stock with a Beta of 2