The stock of ABC, Inc. has a beta of 1.10. The market rate of return is expected to increase in value by 5%. ABC stock should
A) increase in value by 0.5%.
B) increase in value by 5.5%.
C) decrease in value by 0.5%.
D) decrease in value by 5.5%.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected return on a stock is equal to the risk-free rate plus the product of the stock's beta and the market risk premium (the difference between the expected market return and the risk-free rate). In this case, if the market rate of return is expected to increase by 5%, and ABC, Inc. has a beta of 1.10, then the expected return on ABC stock is:

Expected return = risk-free rate + beta x market risk premium
Expected return = 0 (assume risk-free rate to be zero) + 1.10 x 5%
Expected return = 5.5%

Therefore, ABC stock should increase in value by 5.5%.

The Stock of ABC, Inc