Question

Stock Y has a beta of 1.20 and an expected return of 11.4 percent. Stock Z has a beta of .80 and an expected return of 8 percent. What would the risk-free rate have to be for the two stocks to be correctly priced relative to each other? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate

Answer 1

Expected return=risk free rate+beta*(market rate-risk free rate)

11.4=Rf+1.2*(Rm-Rf)

11.4=1.2*Rm-0.2Rf

Rm=(11.4+0.2Rf)/1.2

Also:

8=Rf+0.8*(Rm-Rf)

8=0.8Rm+0.2Rf

8=0.8*(11.4+0.2Rf)/1.2+0.2Rf

8=7.6+0.1333Rf+0.2Rf

Rf=(8-7.6)/(0.1333+0.2)

=1.2%=risk free rate