Question

 Assume that the​ risk-free rate, Upper R Subscript Upper F​, is currently 9​%, the market​ return, r Subscript m​, is 13 %​, and asset A has a​ beta, b Subscript Upper A​, of 1.39. a.  Use CAPM to estimate the required​ return, r Subscript Upper A​, on asset A. Which of the following graphs represents the security market line​ (SML) and the required return for asset​ A?

b.  Assume that as a result of recent economic​ events, inflationary expectations have declined by 2​%, lowering Upper R Subscript Upper F and r Subscript m to 7​% and 11​%, respectively. Which of the following graphs represents the new SML and shows the new required return for asset​ A?

c.  Assume that as a result of recent​ events, investors have become more risk​ averse, causing the market return to rise by 1 %​, to 14​%. Ignoring the shift in part b​, which of the following graphs shows the new SML and the new required return for asset​ A?

Answer 1

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Answer:

a) Using CAPM, Ra = Rf + beta x (Rm - Rf) = 9% + 1.39 x (13% - 9%) = 14.56%

Select the graph that connect three points (0, 9%), (1.39, 13.56%) and (1, 13%)

b) Ra = 7% + 1.39 x (11% - 7%) = 12.56%

Select a line which will be a parallel to the earlier line but downward starting with 7%.

c) Ra = 9% + 1.39 x (14% - 9%) = 15.95%

This line will have a different slope.