Question

Suppose r_RF = 3%, r_M = 13%, and b_i = 1.8.

2. Now suppose r_RF decreases to 2%. The slope of the SML remains constant. How would this affect r_M and r_i?

-Select-IIIIIIIVVItem 3

1. What is r_i, the required rate of return on Stock i? Round your answer to one decimal place.

     %

2. 1. Now suppose r_RF increases to 4%. The slope of the SML remains constant. How would this affect r_M and r_i?
   1. r_M will remain the same and r_i will increase by 1 percentage point.
   2. r_M will increase by 1 percentage point and r_i will remain the same.
   3. Both r_M and r_i will decrease by 1 percentage point.
   4. Both r_M and r_i will remain the same.
   5. Both r_M and r_i will increase by 1 percentage point.

   -Select-

   1. r_M will remain the same and r_i will decrease by 1 percentage point.
   2. Both r_M and r_i will increase by 1 percentage point.
   3. Both r_M and r_i will remain the same.
   4. Both r_M and r_i will decrease by 1 percentage point.
   5. r_M will decrease by 1 percentage point and r_i will remain the same.
3. 1. Now assume that r_RF remains at 3%, but r_M increases to 14%. The slope of the SML does not remain constant. How would these changes affect r_i? Round your answer to one decimal place.

   The new r_i will be   %.

   2. Now assume that r_RF remains at 3%, but r_M falls to 12%. The slope of the SML does not remain constant. How would these changes affect r_i? Round your answer to one decimal place.

   The new r_i will be   %.

Answer 1

I can only answer 1 question at a time, so I am solving question 1 only.

" Suppose r_RF = 3%, r_M = 13%, and b_i = 1.8.

2. Now suppose r_RF decreases to 2%. The slope of the SML remains constant. How would this affect r_M and r_i?"

We know: r_i = r_RF + b_i * (r_M - r_RF), where, (r_M - r_RF) is the slope of SML.

at r_RF = 3%, r_M = 13%, and b_i = 1.8, r_i = 3+1.8*(13-3) = 21.0%

Now if r_RF decreases to 2% and the slope of the SML remains constant:

(r_M - r_RF) = 10 which gives us r_M = 10% + 2% = 12%

r_i = 2+1.8*(12-2) = 20.0%

Hence, III. Both r_M and r_i will decrease by 1 percentage point.

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