Question

Polly Khan is trying to calculate the current market rate given the following information: Investor’s have been requiring a 12% annual return on Builtrite’s stock which has a beta of 2.0 and the current risk-free rate is 4%. What is the current market rate?

Answer 1

Answer:

The current market rate is 8%

Explanation:

The market rate is the return on market or the market portfolio. To calculate the market rate (rM) we will use the CAPM equation which is used to calculate the required rate of return on a stock or portfolio. The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate
• rM is the market rate

We already know the value of r, rRF and Beta. We will input these values in the above equation to calculate the market rate.

0.12 = 0.04 + 2 * (rM - 0.04)

0.12 - 0.04 = 2 * rM - 0.08

0.08 + 0.08 = 2 * rM

0.16 / 2 = rM

rM = 0.08 or 8%