Question

The expected return on JK stock is 14.40 percent while the expected return on the market is 11.4 percent. The beta of JK stock is 1.4. What is the risk-free rate of return? 3.90 percent 4.30 percent 3.40 percent 2.50 percent 2.76 percent

Answer 1

As per Capital Asset Pricing Model [CAPM], The Expected Rate of Return is computed by using the following equation

Expected Rate of Return = Risk-free Rate + Beta(Market Rate - Risk-free Rate]

= Rf + B[Rm-Rf]

Where; Rf = Risk free rate

Rm = Market Rate

B = Beta of the stock

In this given question, We have Expected Rate of Return = 14.40%

Beta = 1.4

Market Rate = 11.40%

Risk-free Rate = ?

After substituting the given data into the equation,

Expected Rate of Return = Rf + B[Rm-Rf]

0.1440 = Rf + 1.4(0.1140 – Rf)

0.1440 = Rf + 0.1596 – 1.4Rf

0.0156 = 0.40Rf

Rf = 0.0156 / 0.40

Rf = 0.0390

Rf = 3.90%

“Therefore, The Risk-free rate of return = 3.90 Percent”