Question

Suppose you observe the following situation: Security Beta Expected Return Pete Corp. 1.25 .1323 Repete Co. .87 .0967 a. Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market

Answer 1

The expected return on the market rate is 10.59%

Step-by-step explanation:

Expected return=risk-free rate +Beta*(market rate- risk-free rate)

13.23 = Rf + 1.25*(Rm-Rf)

13.23 = 1.25Rm- 0.25Rf

Rm = (13.23 + 0.25Rf ) / 1.25 .............(equ i)

9.67 = Rf+0.87*(Rm-Rf)

9.67 = 0.13Rf+0.87Rm

Substitute (13.23+0.25Rf)/1.25 for Rm from equ (i)

9.67 = 0.13Rf+0.87*(13.23+0.25Rf)/1.25

9.67 = 0.13Rf+9.20808+0.174Rf

Rf = (9.67-9.20808)/(0.13+0.174)

Rf = 0.46192 / 0.304

Rf = 1.519474

Rf = 1.52%

Hence, Risk free rate is 1.52%

From the equ (i)

Rm = (13.23+0.25Rf)/1.25

Rm = (13.23+0.25(1.52%)/1.25

Rm = (13.23+0.003 ) /1.25

Rm = (13.23+0.003 ) /1.25

Rm = 13.233 / 1.25

Rm = 10.5864

Rm = 10.59%

Hence, expected return on Market rate is 10.59%