Asked by Kelvyn almanzar on Jun 24, 2024
Verified
Compute the risk premium for the stock of Omega Tools if the risk-free rate is 6%, the expected market return is 12%, and Omega's stock has a beta of 0.8.
A) 10.8%
B) 4.8%
C) 48.0%
D) 16.8%
Risk Premium
The extra return expected by investors for taking on additional risk over the risk-free rate.
Risk-Free Rate
The risk-free rate is the theoretical return of an investment with zero risk, typically represented by the yield on government securities.
- Understand the connection between risk and return and its impact on the decision-making process for investments.
Verified Answer
AD
Aleksandra DmitrievaJun 30, 2024
Final Answer :
B
Explanation :
The formula for calculating the required rate of return using the capital asset pricing model (CAPM) is:
Required rate of return = risk-free rate + beta x (expected market return - risk-free rate)
Plugging in the given values:
Required rate of return = 6% + 0.8 x (12% - 6%)
Required rate of return = 6% + 0.8 x 6%
Required rate of return = 6% + 4.8%
Required rate of return = 10.8%
The risk premium is the difference between the required rate of return and the risk-free rate:
Risk premium = Required rate of return - Risk-free rate
Risk premium = 10.8% - 6%
Risk premium = 4.8%
Therefore, the answer is B.
Required rate of return = risk-free rate + beta x (expected market return - risk-free rate)
Plugging in the given values:
Required rate of return = 6% + 0.8 x (12% - 6%)
Required rate of return = 6% + 0.8 x 6%
Required rate of return = 6% + 4.8%
Required rate of return = 10.8%
The risk premium is the difference between the required rate of return and the risk-free rate:
Risk premium = Required rate of return - Risk-free rate
Risk premium = 10.8% - 6%
Risk premium = 4.8%
Therefore, the answer is B.
Learning Objectives
- Understand the connection between risk and return and its impact on the decision-making process for investments.