Use the security market line to determine the required rate of return for the following firm's stock.The firm has a beta of 1.20,the required return in the market place is 10.00%,and the risk-free rate of return is 1.50%.
A)11.70%
B)10.70%
C)7.20%
D)2.80%

Question

Quizplus · Accepted Answer

The security market line (SML) is a linear relationship between the expected return and the beta of a security. The required rate of return for a stock can be determined by using the SML formula:

Expected return = Risk-free rate + Beta x (Market return - Risk-free rate)

Using the given information:

Risk-free rate = 1.50%

Market return = 10.00%

Beta = 1.20

Expected return = 1.50% + 1.20 x (10.00% - 1.50%)

Expected return = 1.50% + 1.20 x 8.50%

Expected return = 11.70%

Therefore, the required rate of return for the stock is 11.70%. Option A) is the correct choice.

Use the Security Market Line to Determine the Required Rate