Question

Suppose r_RF = 4%, r_M = 10%, and b_i = 1.2.

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

   -Select-IIIIIIIVVItem 2

   1. Both r_M and r_i will remain the same.
   2. Both r_M and r_i will decrease by 1 percentage point.
   3. r_M will decrease by 1 percentage point and r_i will remain the same.
   4. r_M will remain the same and r_i will decrease by 1 percentage point.
   5. Both r_M and r_i will increase by 1 percentage point.
3. 1. Now assume that r_RF remains at 4%, but r_M increases to 11%. 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 4%, but r_M falls to 9%. 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

a)
What is ri, the required rate of return on Stock i?
=4%+1.2*(10%-4%)
=11.2000%

b)
1.
Now suppose rRF increases to 5%. The slope of the SML remains constant. How would this affect rM and ri?
Both rM and ri will increase by 1 percentage point.

2.
Now suppose rRF decreases to 3%. The slope of the SML remains constant. How would this affect rM and ri?
Both rM and ri will decrease by 1 percentage point.

c)
1.
Now assume that rRF remains at 4%, but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect ri?
=4%+1.2*(11%-4%)
=12.4000%

2.
Now assume that rRF remains at 4%, but rM falls to 9%. The slope of the SML does not remain constant. How would these changes affect ri?
=4%+1.2*(9%-4%)
=10.0000%