# Beta and the risk return rate

If the beta of portfolio is .326, the present yield to maturity on U.S. government bonds maturing in one year (currently about 4.5% annually) and an assessment that the market risk premium (that is - the difference between the expected rate of return on the 'market portfolio' and the risk-free rate of interest) is 6.5%, using the CAPM equation,what is the present 'cost of equity' of my company? And what is the meaning of the 'cost of equity?' How would a 3-stock portfolio hold up with a beta of .326? Can it be diversified? Please explain, including the concept of beta and the risk/return trade off to eliminate my confusion.

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#### Solution Preview

Risk Free Rate = 4.5%

Market Risk Premium = 6.5%

Beta = .326

Thus the cost of equity = Risk Free Rate + Beta*Risk Premium

= 4.5% + .326*6.5%

= 6.62%

Cost of Equity: The return of an investment required by the equity holders of a firm. Thus the equity holders of this portfolio require a 6.62% return on their investment.

A portfolio can be diversified by adding more stocks. In this case, it would help if we add more stocks whose ...

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