Question

The risk-free return is 5.79 percent, the expected return on the market is 13.8 percent, the expected real return for Litchfield Design stock is 3.64 percent, and the beta for Litchfield Design stock is 0.6. What is the inflation rate expected to be? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 5.79 + 0.6 * (13.8 - 5.79)

Expected return% = 10.6 = nominal return

Real return = ((1+nominal return)/(1+inflation rate)-1)*100

0.0364=((1+0.106)/(1+inflation rate)-1)*100

inflation rate% = 6.72 = 0.0672