A stock has an expected return of 10 percent, a beta of 1.50, and the expected r

Question

A stock has an expected return of 10 percent, a beta of 1.50, and the expected return on the market is 8 percent. What must the risk-free rate be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

A stock has an expected return of 10 percent, a beta of 1.50, and the expected return on the market is 8 percent. What must the risk-free rate be? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Answer:

Calculation of Risk Free rate using CAPM formula :

As per CAPM :

Expected return =Risk Free rate + Beta * (Market rate – Risk Free rate )

10 =Risk Free rate + 1.50 * (8 – Risk Free rate )

10 = Risk free rate + 12 – 1.5 Risk Free rate

10 = 12 – 0.5 Risk Free rate

Risk Free rate = (12-10) /0.5

= 4

Hence Risk Free rate is 4%

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