Company X has beta = 1.6, while Company Y's beta = 0.7.The risk-free rate is 7%, and the required rate of return on an average stock is 12%.Now the expected rate of inflation built into rRF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14%, and betas remain constant.After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?
A)3.75%
B)4.20%
C)4.82%
D)5.40%
E)5.75%

Question

Quizplus · Accepted Answer

The required return on a stock can be calculated using the Capital Asset Pricing Model (CAPM): Required return = Risk-free rate + Beta * (Market return - Risk-free rate). Initially, the required return on Stock X is 15% and on Stock Y is 10.5%. After the changes, the required return on Stock X is 16.8% and on Stock Y is 11.4%. The difference is 5.4%.

Company X Has Beta = 1