A stock has a beta of 1.5, the market risk premium is 9%, and the risk-free rate is 5%.
a. What is the required rate of return on this stock?
b. What is the expected return on the market?
c. If based on your personal opinion the stock will generate a return of 20%, is the stock over-valued or under-valued? Would you buy or sell the stock?
To find the required rate of return on a stock, you need to use the following formula:
Required Rate of Return = Risk Free Rate + (Beta * Market Risk Premium)
Now you plug in the numbers you already know:
Required Rate of Return = 5% + (1.5 * 9%)
Required Rate …
This solution explains how to calculate required rate of return and expected return on the market for a stock given the beta value, market risk premium, and the risk-free rate.