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The two-factor model on a stock provides a risk premium for exposure to market risk of 9%, a risk premium for exposure to interest rate risk of (-1.3%), and a risk-free rate of 3.5%. The beta for exposure to market risk is 1, and the beta for exposure to interest rate risk is also 1. What is the expected return on the stock?

Respuesta :

Answer:

11.20%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta of market risk × Market rate risk + Beta of interest rate risk × interest rate risk )

= 3.5% + 1 × 9% + 1 × -1.3%

= 3.5% + 9% - 1.3%

= 11.20%

Since in this question, two betas is given for each type of risk, so the calculation is done on that basis only which is shown above.

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