Question

Stock A has an expected return of 15.6 percent and a beta of 1.27. Stock B has an expected return of 11.4 percent and a beta of 0.89. Both stocks have the same reward-to-risk ratio. What is the risk-free rate

Answer 1

The risk free rate is 1.5632%

Step-by-step explanation:

The expected return of stock is calculated with the formula

`Return=Riskfree + Beta * Premium market risk`

So, for A and B, the calculation is

• A -->
  `0.156 = X + 1.27*Y`

• B -->
  `0.114 = X + 0.89*Y`

If we clear X in the first equation and we replace that in the second, we get:

• 
  `X = 0.156 - 1.27*Y ---> 0.114 = 0.156 - 1.27*Y+0.89*Y`
• 
  `0.042 = 0.38*Y ---> Y = (0.042)/(0.38) = 0.110526316`
• 
  `X = 0.156 - 1.27 * 0.110526316 = 0.015632 = 1.5632%`