Question

Suppose rRF = 5%, rM = 10%, and bi = 1.8.

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

1. Now suppose rRF increases to 6%. The slope of the SML remains constant. How would this affect rM and ri?

Both rM and ri will decrease by 1%.

Both rM and ri will remain the same.

Both rM and ri will increase by 1%.

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

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

2. Now suppose rRF decreases to 4%. The slope of the SML remains constant. How would this affect rM and ri?

Both rM and ri will increase by 1%.

Both rM and ri will remain the same. 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%

1. Now assume that rRF remains at 5%, but rM increases to 11%. 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 5%, but rM falls to 9%. 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

What is ri, the required rate of return on Stock i?
=5%+1.8*(10%-5%)=14.00%

1. Now suppose rRF increases to 6%. The slope of the SML remains constant. How would this affect rM and ri?

Both rM and ri will increase by 1%.

2. Now suppose rRF decreases to 4%. The slope of the SML remains constant. How would this affect rM and ri?

Both rM and ri will decrease by 1%.

1. Now assume that rRF remains at 5%, but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect ri?
The new ri will be =5%+1.8*(11%-5%)=15.8%

2. Now assume that rRF remains at 5%, but rM falls to 9%. The slope of the SML does not remain constant. How would these changes affect ri?
The new ri will be =5%+1.8*(9%-5%)=12.2%