Final answer:
The risk-free rate of return can be calculated using the Capital Asset Pricing Model (CAPM), which considers the expected return of an investment based on its beta and the market's risk-free rate of return. In this case, the risk-free rate of return is 6.8%.
Step-by-step explanation:
The risk-free rate of return can be calculated using the Capital Asset Pricing Model (CAPM). CAPM is a financial model that determines the expected return of an investment based on its beta and the market's risk-free rate of return.
The formula for calculating the expected return using CAPM is: Expected Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate).
In this case, the expected return on Hilo stock is 15.40% and the expected return on the market is 12.5%. The beta of Hilo is 1.51.
Let's solve the equation using the given data:
15.40% = Risk-free Rate + 1.51 * (12.5% - Risk-free Rate)
15.40% = Risk-free Rate + 18.875% - 1.51 * Risk-free Rate
15.40% - 18.875% = -0.51 * Risk-free Rate
-3.475% = -0.51 * Risk-free Rate
Risk-free Rate = -3.475% / -0.51
Risk-free Rate = 6.8%