Question

Assume that expected return of the stock A in Rachel’s portfolio is 13.6% this year. The risk premium on the stocks of the same industry are 4.8%, betas of these stocks is 1.5 and the inflation rate was 2.7%. Calculate the risk-free rate of return using Capital Market Asset Pricing Model (CAPM).

Answer 1

6.4%

Explanation:

Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.

As per given data

Expected return = 13.8%

Market Risk premium = Mrp = 4.8%

Investment beta =
`\beta` = 1.5

Formula for CAPM

Expected return = Risk free rate + beta ( market risk premium )

Expected Return = Rf +
`\beta` ( Mrp)

As we have the expected return, we need to calculate the the risk free rate.

13.6% = Rf + 1.5 ( 4.8% )

13.6% = Rf + 7.2%

Rf = 13.6% - 7.2%

Rf = 6.4%