ST 3

a What is the holding companys beta?

= .6*.7+.25*.9+.10*1.3 + .05*1.5 = 0.85
b Assume that the risk-free rate is 6 percent and the market risk premium is
5 percent. What is the holding companys required return?
R = 6 + 0.85(5) = 10.25%
c
Holding companys beta B= 0.5*0.7+0.25*0.225+0.1*1.3+0.15*1.5= 0.225
Holding companys S rate of return = 6 + 0.93* 5 = 10.65
Problem 8-3
Assume that the risk-free rate is 6 percent and the expected return on the
market is 13 percent. What is the required rate of return on a stock with a beta of
0.7?
rRF = 6%; rM = 13%; b = 0.7; r = ?
r = rRF + (rM rRF)b
= 6% + (13% 6%)0.7
= 10.9%.
Problem 8-5
A stock has a required return of 11%; the risk-free rate is 7%; and the market
risk premium is 4%.
a. What is the stocks beta?
b. If the market risk premium increased to 6%, what would happen to the stocks
required rate of return? Assume that the risk-free rate and the beta remain
unchanged
a. r = 11%; rRF = 7%; RPM = 4%.
r = rRF + (rM rRF)b
11% = 7% + 4%b
4% = 4%b
b = 1.
b. rRF = 7%; RPM = 6%; b = 1.
r = rRF + (rM rRF)b
= 7% + (6%)1
= 13%.

Problem 8-9
Cost of Equity = Risk Free Rate + (Beta X Market Risk Premium)
In this case, the market risk premium is simply the average return on a stock (13%)
less the risk free rate (7%)
Cost of Equity for Stock R = 7% + (1.5 x 6%), = 16% rate of return
Cost of Equity for Stock S = 7% + (0.75 x 6%) =11.5% rate or return