Stock A has a beta of 1

Finance Apr 02, 2021

Stock A has a beta of 1.74 and an expected return of 20.2 percent. Stock B has a beta of 1.08 and an expected return of 15.4 percent. If CAPM holds, what should the return on the market and the risk-free rate be? (Round intermediate calculations and the final answers to 2 decimal places, e.g. 2.36%.)

Expert Solution

Using CAPM Model,

Required Rate of Return = Risk-free Rate+Beta*Market Risk Premium

0.202 = Risk-free Rate + 1.74*Market Risk Premium

0.154 = Risk-free Rate + 1.08*Market Risk Premium

Equating both,

0.202 = 0.154 + (1.74 - 1.08)*Market Risk Premium

0.202 = 0.154 + 0.66*Market Risk Premium

0.202 - 0.154 = 0.66*Market Risk Premium

Market Risk Premium = 0.0727 or 7.27%

0.202 = Risk-free Rate + 1.74*0.0727

Risk-free Rate = 7.55%

So, Risk Free Rate = 7.55%

Market Rate = 0.0727 + 0.0755

Market Rate = 14.82%

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