Question

Suppose you observe the following situation: Security Beta Expected Return Pete Corp. 1.80 .190 Repete Co. 1.49 .163 a. Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the risk-free rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a. 12.03%

b. 3.32%

Step-by-step explanation:

The computation is shown below:

As we know that

Expected rate of return = Risk free rate of return + [Beta × Risk premium]

Let us assume Risk free rate of return be x and Risk premium be y

Now the equations are as follows

For Pete Corp

19 = x + 1.80y ...................... (1)

For Repete Corp

16.3 = x + 1.49y .....................(2)

Now Solving (1) and (2)

After solving we get

y = 8.70967741935

x = 3.3225806452

i.e Risk free rate = x = 3.32%

And, the Risk premium = 8.70967741935%

So,

Expected return on market = Risk free rate + Risk premium

= 3.3225806452 + 8.70967741935

= 12.03%