Question

Stock Y has a beta of 0.7 and an expected return of 8.1 percent. Stock Z...

Stock Y has a beta of 0.7 and an expected return of 8.1 percent. Stock Z has a beta of 1.8 and an expected return of 13.37 percent. What would the risk-free rate (in percent) have to be for the two stocks to be correctly priced relative to each other? Answer to two decimals.

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Answer #1
Let Risk free rate = x
and Market risk premium = y
Stock Y
8.10 = x+ 0.7y
Stock Z
13.37 = x + 1.8y
Multiply first equation by 1.8 and second equation by 0.7
we get
14.58   = 1.8 x +1.26y
9.36    = 0.7 x + 1.26y
Subtract both the equation, we get
1.1 x=   5.22
x   =4.75
Therefore, Rsk free rate = 4.75%
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