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?

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.