1. A stock has an expected return of 10.4 percent, the risk-free rate is 3 perce

Question

1. A stock has an expected return of 10.4 percent, the risk-free rate is 3 percent, and the market risk premium is 5 percent. What must the beta of this stock be? (Round your answer to 2 decimal places. (e.g., 32.16))

Beta of stock?

2. A stock has an expected return of 11.5 percent, its beta is 1.65, and the expected return on the market is 9.2 percent. What must the risk-free rate be? (Round your answer to 2 decimal places. (e.g., 32.16))

2. A stock has an expected return of 11.5 percent, its beta is 1.65, and the expected return on the market is 9.2 percent. What must the risk-free rate be? (Round your answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

1. As per CAPM

stock return = risk free rate+beta*market premium

Putting values in the above formula,

10.4% = 3%+beta*5%

or, 7.4% = beta*5%

or beta = 7.4/5 = 1.48

2. Putting values in the CAPM formula as given in part 1 above,

11.5% = risk free+1.65*(9.2 - risk free)

Let risk free rate be x

so, 11.5% = x+15.18 - 1.65x

or, 11.5% = 15.18 - 0.65x

or 0.65x = 3.68%

or x = 5.66

Thus risk free rate is 5.66%

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