Stock Y has a beta of 1.7 and an expected return of 18 percent. Stock

QUESTION

Stock Y has a beta of 1.7 and an expected return of 18 percent. Stock Z has a beta of 0.5 and an expected return of 9 percent. For the two stocks to be correctly priced, the risk-free rate would have to be _________percent.(Do not include the percent sign (%). Round your answer to 2 decimal places. ¦
Based on CAPM, E(r) = Rf beta*(E(Rm) “ Rf), where E(r) stands for the expected return, Rf stands for risk-free rate and E(Rm) stands for the expected return of the market. We are given Y has a beta of 1.7 and E(r) = 0.18 and Z has a beta of 0.5 and E(r) = 0.09. Therefore, we can set up¦

the equation as follows: 0.18 = Rf 1.7 * (E(Rm) “ Rf) 0.09 = Rf 0.5 * (E(Rm) “ Rf) Solve that and we get Rf = 5.25% E(Rm) = 12.75%. So, the risk-free rate would have to be 5.25% based on CAPM.

ANSWER:

CLICK REQUEST FOR  AN EXPERT SOLUTION