Question

13. Consider a Market Portfolio with 12% expected return and 20% return standard deviation. If the Sharpe ratio of the market portfolio is 0.5, what is the risk-free rate of return? (a) 0.01 (b) 0.02 (c) 0.03 (d) 0.04

Answer 1

Expected return = 12% or 0.12

Return standard deviation = 20% or 0.20

Sharpe ratio = 0.5

Calculate the risk-free return -

Sharpe ratio = [Expected return - Risk free return]/Return standard deviation

0.5 = [0.12 - Risk free return]/0.20

0.1 = 0.12 - Risk free return

Risk free return = 0.12 - 0.1 = 0.02

The risk-free return is 0.02

Hence, the correct answer is the option (b).