What will happen to the expected return on a stock with a beta of 1.5 and a market risk premium of 9% if the Treasury bill yield increases from 3 to 5%?
A) The expected return will remain unchanged.
B) The expected return will increase by 1.0%.
C) The expected return will increase by 2.0%.
D) The expected return will increase by 3.0%.

Question

Quizplus · Accepted Answer

The expected return on a stock is calculated as the risk-free rate plus the product of beta and the market risk premium. With a beta of 1.5 and a market risk premium of 9%, the expected return is currently 3% + (1.5 x 9%) = 16.5%. If the Treasury bill yield increases from 3% to 5%, the risk-free rate increases by 2%. As a result, the expected return on the stock will increase by 2% x 1.5 (beta) = 3%. Therefore, the new expected return will be 16.5% + 3% = 19.5%. Hence, option C is the best choice.

What Will Happen to the Expected Return on a Stock