Stock R has a beta of 1.2, Stock S has a beta of 0.75, the required return on an average stock is 13%, and the risk-free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock

The required return on the riskier stock (R) exceed the required return on

the less risky stock (S) by = 2.7%

Explanation:

Using the CAPM, we can calculate the required rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

rRF is the risk free rate

rM is the market return or return on average stock

r of stock R = 0.07 + 1.2 * (0.13 - 0.07)

r of stock R = 14.2%

r of stock S =  0.07 + 0.75 * (0.13 - 0.07)

r of stock S = 11.5%

R is the riskier stock because it has a higher beta than S which is the less riskier stock.

The required return on the riskier stock (R) exceed the required return on

the less risky stock (S) by = 14.2 - 11.5  = 2.7%