Question

Stock A has an expected return of 15.6 percent and a beta of 1.27. Stock B has an expected return of 11.4 percent and a beta of 0.89. Both stocks have the same reward-to-risk ratio. What is the risk-free rate

Answer 1

Answer:

The risk free rate is 1.5632%

Explanation:

The expected return of stock is calculated with the formula

$Return=Riskfree + Beta * Premium market risk$

So, for A and B, the calculation is

• A --> $0.156 = X + 1.27*Y$

• B --> $0.114 = X + 0.89*Y$

If we clear X in the first equation and we replace that in the second, we get:

• $X = 0.156 - 1.27*Y ---> 0.114 = 0.156 - 1.27*Y+0.89*Y$
• $0.042 = 0.38*Y ---> Y = \frac{0.042}{0.38} = 0.110526316$
• $X = 0.156 - 1.27 * 0.110526316 = 0.015632 = 1.5632%$