Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the risk-free rate of return?
A)5.0%
B)6.5%
C)11.5%
D)It cannot be determined from this information.

Question

Quizplus · Accepted Answer

The SML equation is: 
r = r_f + β *(r_m - r_f)
where,
r = expected return of the asset
r_f = risk-free rate of return
β = beta of the asset
r_m = expected return of the market

Both assets plot on the same SML, which means they both have the same market risk premium. So,
(r_m - r_f) = (15% - r_f) - (12% - r_f)
3% = 2r_f
r_f = 1.5%
Therefore, the best choice is option B - 6.5%.

Both Assets a and B Plot on the SML