A stock has a beta of 1.5 and an expected return of 16.35%. What is the risk-free rate if the market rate of return is 12.5%? %

Answer:

As we know, as per CAPM formula;

Expected Return of Stock = Rf + Beta of Security*(Rm- Rf)

Here

Rf means Risk free Rate

Rm means Market rate of return

Therefore,

16.35% =Rf +1.5*(12.5%-Rf)

16.35% = Rf +18.75%-1.5Rf

16.35%-18.75% = -0.5Rf

-2.40%=-0.5Rf

Rf = -2.40%/-0.5

Rf = 4.80%

Therefore, Risk free rate = 4.80%