Question

Suppose you observe the following situation: Security Pete Corp. Repete Co. Beta 1.25 .94 Expected return 13.50% 10.80 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? (Do not round intermediate calculations. Round the final answers to 2 decimal places.) Expected return on market O % What is the risk-free rate? (Do not round intermediate calculations. Round the final answer to 2 decimal places.) Risk-free rate 0 %

Answer 1

Ans:

Expected return on market = 11.32%

Risk free return = 2.61%

Workings:

CAPM:

Cost of capital = Risk free capital + Beta * ( Expected market return - risk free rate)

Applying above:

For P: 13.5% = Risk free rate + 1.25 * ( Expected market return - risk free rate)

For R : 10.8 % = Risk free rate + 0.94 * ( Expected market return - risk free rate)

( Expected market return - risk free rate) = 2.7% / 0.31 = 8.70968

Risk free return : 10.8% = Risk free rate + 0.94 * 8.70968%

= 2.61%

Expected return on market : 8.70968% + 2.61% = 11.32%

Ans:

Expected return on market = 11.32%

Risk free return = 2.61%