T. Corporation has a standard deviation on its common stock of 75 percent and a correlation with market returns of 0.40. The market's standard deviation and expected return are 15 percent and 14 percent, respectively, and the risk-free rate of return is 8 percent. Calculate T. Corporation's required rate of return.
A)1.867%
B)9.867%
C)19.20%
D)14.06%

Question

Quizplus · Accepted Answer

The formula for required rate of return using the Capital Asset Pricing Model (CAPM) is:

R = Rf + beta(Rm - Rf)

Where:
R = required rate of return
Rf = risk-free rate of return
beta = correlation of T. Corporation's stock returns with market returns
Rm = expected return on the market

First, we need to find T. Corporation's beta using the formula:

beta = (standard deviation of T. Corp. / standard deviation of market) * correlation

beta = (0.75 / 0.15) * 0.40 = 2

Plugging in the given values, we get:

R = 0.08 + 2(0.14 - 0.08)
R = 0.08 + 0.12
R = 0.20 or 20%

Therefore, the required rate of return for T. Corporation is 20%. The closest option is C, 19.20%.

T Corporation Has a Standard Deviation on Its Common Stock