Question

Suppose you have following information:

Security           Beta                 Expected return

Fires Inc.         1.47                 16.2%

Day Co.           0.84                 12.7%

What would the risk-free rate have to be for the securities to be correctly priced?

Question 20 options:

	12.00%
	13.12%
	9.78%
	8.00%
	13.59%

Answer 1

Acc to CAPm Ret,

SML Ret or CAPM Ret = Rf + Beta ( Rm - Rf )
Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

0.162 = Rf + 1.47( Rm- Rf ) --------- ( 1 )

0.127 = Rf + 0.84 ( Rm - Rf ) --------- ( 2 )

On solving 1 & 2

0.63 ( Rm - Rf ) = 0.035

Rm - Rf = 0.035 / 0.63

= 0.0556

Substituting Rm - Rf in equition 1

0.162 = Rf + 1.47 ( 0.0556)

0.162 = Rf + 0.0817

Rf = 0.162 - 0.0817

= 0.0803 i.e 8.03%

option D is correct.

Pls do rate, if the answer is correct and comment, if any further assistance is required.