Question

Stock A has a beta of 1.76 and an expected return of 19.8 percent. Stock B has a beta of 1.16 and an expected return of 14.6 percent. If CAPM holds, what should the return on the market and the risk-free rate be? (Round intermediate calculations and the final answers to 2 decimal places, e.g. 2.36%.)

Answer 1

The CAPM equation is used to determine the expected return on an investment based on its beta and the risk-free rate. To find the return on the market and the risk-free rate, we can solve a system of equations using the given information.

Step-by-step explanation:

The CAPM (Capital Asset Pricing Model) equation is used to determine the expected return on an investment based on its beta and the risk-free rate.

The formula is: Expected Return = Risk-Free Rate + (Beta * (Market Return - Risk-Free Rate))

From the given information, Stock A has a beta of 1.76 and an expected return of 19.8%, while Stock B has a beta of 1.16 and an expected return of 14.6%.

By comparing the expected returns of stock A and stock B with their respective betas, we can calculate the return on the market and the risk-free rate. Using the formula, we substitute the values:

19.8% = Risk-Free Rate + (1.76 * (Market Return - Risk-Free Rate))

14.6% = Risk-Free Rate + (1.16 * (Market Return - Risk-Free Rate))

This is a system of equations that can be solved simultaneously to find the Market Return and the Risk-Free Rate.