Question

Suppose you have following information: Security           Beta                 Expected return Fires Inc &nb

Suppose you have following information:

Security           Beta                 Expected return

Fires Inc          1.7                   16.2%

Day Co.           0.5                   12.7%

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

8.66%

12.00%

13.12%

11.24%

14.16%
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Homework Answers

Answer #1
Expected return = Risk free rate + Beta * Market risk premium
Fires Inc.
16.2% = Risk free rate + 1.7 * Market risk premium Equation 1
Day Co.
12.7% = Risk free rate + 0.5 * Market risk premium Equation 2
Subtract equation 2 from equation 1
3.5% = 1.2 * Market risk premium
Market risk premium = 3.5% / 1.2 2.92%
Put the value of Market risk premium in equation 1
16.2% = Risk free rate + 1.7 * 2.92%
16.2% = Risk free rate + 4.96%
Risk free rate = 16.2% - 4.96% 11.24%
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