Consider two stocks, Coca-Cola Company (KO) and Pepsico, with expected returns o

Question

Consider two stocks, Coca-Cola Company (KO) and Pepsico, with expected returns of 8% and 12% respectively. Assume that the stocks have standard deviations of 12% and 14% respectively.

(my personal calculations after finding the weights of KO and PEP in a portfolio with a -1 correlation): the expected return on this portfolio is E(return_portfolio) = W*E(return_KO) + (1-W)*E(return_PEP) = 0.0981 or 9.81%

IF THE MARKETS ARE EFFICIENT, WHAT MUST THE RISK-FREE RATE BE IN THIS ECONOMY? (I'm assuming this refers to the CAPM pricing model and I have to calculate beta first, but I don't know how) - PLEASE SHOW YOUR WORK

Explanation / Answer

yes you have to calculate beta first then using CAPM u can calculate Risk free rate

(beta)KO = covarience/ sd(KO)^2

(beta)PEP = covarience/ sd(PEP)^2

r(correlation) = covariance/(sd(KO) * sd(PEP) )

-1 = covariance/(0.12 * 0.14)

covariance = - 0.0168

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