Stock Y has a beta of 1.28 and an expected return of 13.7 percent.Stock Z has a beta of 1.02 and an expected return of 11.4 percent.What would the risk-free rate have to be for the two stocks to be correctly priced relative to each other?
A)2.38 percent
B)2.76 percent
C)3.23 percent
D)3.69 percent
E)4.08 percent

Question

Quizplus · Accepted Answer

The correct answer is A because the risk-free rate would have to be 2.38 percent for the two stocks to be correctly priced relative to each other. This is because the expected return on a stock is equal to the risk-free rate plus the beta of the stock times the expected return on the market. In this case, the expected return on the market is not given, but we can assume that it is 10 percent. Therefore, the expected return on Stock Y is 13.7 percent and the expected return on Stock Z is 11.4 percent. The beta of Stock Y is 1.28 and the beta of Stock Z is 1.02. Therefore, the risk-free rate would have to be 2.38 percent for the two stocks to be correctly priced relative to each other.

Stock Y Has a Beta of 1