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P Corp’s Beta is 1.4 and expected return is 0.150
R Co.’s Beta is 0.9 and expected return is 0.115
Assume securities are correctly priced.Based on CAPM
what is return on market?
What is the Risk Free rate?Please do not simply set me test questions. Presumably you have an answer in the same book as you found the question, so in future say what your problem is and then I will try and help.
You have to use a bit of algebra. Suppose the risk free rate is R and the market premium (market return minus risk free) is P
Then for P Corp: 15 = R + 1.4P
For R Co: 11.5 = R + 0.9PYou should have no problem solving the two equations to find P and R (in just the same way that you are expected to be able to solve equations in Paper F5 for linear programming).
Subtracting the second of the two equations from the first:
3.5 = 0 + 0.5P
P = 3.5 / 0.5 = 7
Substituting for P in the first equation,
15 = R + 1.4×7 = R + 9.8
So R = 5.2
So the risk free rate is 5.2% and the market return is 5.2 + 7 = 12.2%
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