Homework SourseSuppose you observe the following situation Assume these sec
Suppose you observe the following situation:
Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? (Do not round intermediate calculations. Round the final answers to 2 decimal places.)
What is the risk-free rate? (Do not round intermediate calculations. Round the final answer to 3 decimal places.)
| Security | Beta | Expected Return | ||||
| Pete Corp. | 1.20 | 0.130 | ||||
| Repete Co. | 0.89 | 0.103 | ||||
Solution
13% = risk free rate + 1.20 * market risk premium
10.3% = risk free rate + 0.89*market risk premium
subtract the two
2.7% = 0.31 * market risk premium
market risk premium = 2.7/0.31 = 8.7097%
put this in the first equation
13% = risk free rate + 1.2*8.7097%
b. risk free rate = 2.55%
a. expected return on market = market risk premium + risk free rate = 8.7097 + 2.5484 = 11.26%
