Question

A stock has an expected return of 12.8 percent and a beta of 1.19, and the expected return on the market is 11.8 percent. What must the risk-free rate be?

Answer 1

We know from Capital asset pricing model that expected return (ER) of any stock can be calculated as ER = Rf + beta* ( Rm - Rf) where, Rf is risk free rate Rm is expected return on market. Therefore, 0.128 = Rf + 1.19* (0.118 - Rf) which is equivalent to 0.19 Rf = 0.140 - 0.128 Or, risk free rate, Rf = 0.0654 ~ 6.54%