Stock J has a beta of 1.2 and an expected return of 15.6%, and stock K has a beta of 0.8 and an expected return of 12.4%. What is the expected return on the market and the risk-free rate of return, consistent with the capital asset pricing model?

Answer (A) is correct. This problem requires the use of simultaneous equations. Set up a CAPM formula for each stock: Stock J: 15.6 = RF + 1.2 (RM – RF)
Stock K: 12.4 = RF + .8 (RM – RF)
Removing the parentheses and combining terms, you get
Stock J:15.6 = 1.2RM – .2RF
Stock K: 12.4 = .8RM + .2RF
Since one equation has a positive .2 RF term and the other has a negative .2 RF term, we can add the equations together to eliminate the .2 RF term.
(15.6+12.4) = (1.2RM + .8RM) + (–.2RF + .2RF)
28 = 2RM
14 = RM
Substitute 14 for M in the second equation:
12.4 = RF + .8(14 – RF)
12.4 = .2 RF +11.2
1.2 = .2 RF, or RF=6