Question

REQUIRED RATE OF RETURN

Suppose rRF = 6%, rM = 11%, and bi = 1.6.

2. Now suppose rRF decreases to 5%. The slope of the SML remains constant. How would this affect rM and ri?

What is ri, the required rate of return on Stock i? Round your answer to two decimal places.
%

1. Now suppose rRF increases to 7%. The slope of the SML remains constant. How would this affect rM and ri?

rM will remain the same and ri will increase by 1%.

rM will increase by 1% and ri will remain the same.

Both rM and ri will decrease by 1%.

Both rM and ri will remain the same.

Both rM and ri will increase by 1%.

-Select-IIIIIIIVVItem 2  

Both rM and ri will decrease by 1%.

rM will decrease by 1% and ri will remain the same.

rM will remain the same and ri will decrease by 1%.

Both rM and ri will increase by 1%.

Both rM and ri will remain the same.

-Select-IIIIIIIVVItem 3  

1. Now assume that rRF remains at 6%, but rM increases to 12%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to two decimal places.

The new ri will be  %.

2. Now assume that rRF remains at 6%, but rM falls to 10%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to two decimal places.

The new ri will be  %.

Answer 1

According to CAPM theory, ri = rRF+bi(rM-rRF) , ri = 6+1.6(11-6) => ri = 14%

2) If rRF decreases to 5%, and the slope of SML remains constant indicates that the market

risk premium hasn't changed . (Market Risk Premium = rM-rRf)

so , ri = 5%+1.6(11-6)

ri= 13.00%, ri has been decresed by 1%.

1)rRf =7% and The slope of SML Remains constant so Market Risk Premium (rM-rRF) is 5%

ri = 7%+1.6(5%) => ri = 15.00% , which implies rM remains same and ri will increase by 1%

Select-IIIIIIIVVItem 3

1) In this case rRF=6% and rM=12% , and the slope does not remain constant indicates the Market risk premium

has changed .

so ri= 6%+1.6(12-6) => ri = 15.60% , ri has been increased by 1.60%.

2) In this case rRF=6% and rM=10% , and the slope does not remain constant indicates the Market risk premium

has changed .

so ri= 6%+1.6(10-6) => ri = 12.40% , ri has been decreased by 1.60%.