Suppose that there are many stocks in the security market and that the characteristics of stocks A and B are given as follows: Expected Standard Stock A B Return 12% 17 Deviation 5% 11 Correlation = -1 Suppose that it is possible to borrow at the risk-free rate, rf. What must be the value of the risk-free rate? (Hint: Think about constructing a risk-free portfolio from stocks A and B. Since they have a perfect negative correlation, the rate of return will be the r Note: Do not round intermediate calculations. Round your answer to 3 decimal places. Risk-free rate %
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
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Suppose that there are many stocks in the security market and that the characteristics of stocks A and B are given as follows:
Expected
Standard Deviation
Return
12%
17
5%
11
-1
Correlation
Stock
A
B
Suppose that it is possible to borrow at the risk-free rate, rf. What must be the value of the risk-free rate? (Hint: Think about constructing a risk-free portfolio from stocks A and B. Since they have a perfect negative correlation, the
Risk-free rate
%
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