Problem 1134 SML Assume these securities are correctly price

Problem 11-34 SML

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.)

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.)

Solution

14% = risk free rate + 1.3*market risk premium

11.3% = risk free rate + 0.99*maket risk premium

subtract the two

2.7% = 0.31*market risk premium

market risk premium = 8.7097%

put this in the first equation

14% = risk free rate + 1.3*8.7097%

b. risk free rate = 2.68%

a. expected return on market = risk premium + risk free rate = 2.6774% + 8.7097% = 11.39%