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The market price of a security is $70. Its expected rate of return is 12%. The risk-free rate is 7%, and the market risk premium is 7%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)

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tutorAnne

Answer:So the new   Market price of the security =$49.41

Explanation:

In line with the Capital Asset Pricing Model CAPM, we have that  

Expected return= risk free rate+(betaXmarket risk premium)

12=7+ beta x 7

= 12-7 = beta x 7

beta = 5/7 =0.714

IF  beta doubles with other variables constant

 Expected return= risk free rate+(betaXmarket risk premium)

Beta= 0.714 x2 =1.4285

Expected return = 7 + 1.4285 x 7

Expected return 7+ 9.9995=16.995 ≈17%

Price  =  Perpertual Dividend /Expected retrn

where Current Share price =$70

Dividend = $70 x 12%= $8.4

The new Market price =  Perpetual dividend/Required return

= 8.4/17% =$49.41

So the new Market price =$49.41

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