Stock Y has a beta of .95 and an expected return of 14.30 percent. Stock Z has a

Question

Stock Y has a beta of .95 and an expected return of 14.30 percent. Stock Z has a beta of .60 and an expected return of 10 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. Enter your answer as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Stock Y has a beta of .95 and an expected return of 14.30 percent. Stock Z has a beta of .60 and an expected return of 10 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. Enter your answer as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Explanation / Answer

We need to set the reward to risk ratio of the two asset equal to each other, which is

(0.143 – Rf)/0.95 = (0.10- Rf)/0.6

We can cross multiply to get

(0.143 – Rf)* 0.6 = (0.10- Rf)*0.95

Solving for the risk free rate, we find

=0.0858- 0.6Rf = 0.095 – 0.95 Rf

= 0.0092 = 0.35Rf

Rf = 2.63

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