Question

Suppose rRF = 4%, rM = 11%, and bi = 1.5. 2. Now suppose rRF decreases to 3%. The slope of the SML remains constant. How would this affect rM and ri? -Select-IIIIIIIVV What is ri, the required rate of return on Stock i? Round your answer to one decimal place. % 1. Now suppose rRF increases to 5%. 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 percentage point. rM will increase by 1 percentage point and ri will remain the same. Both rM and ri will decrease by 1 percentage point. Both rM and ri will remain the same. Both rM and ri will increase by 1 percentage point. -Select-IIIIIIIVV Both rM and ri will remain the same. Both rM and ri will decrease by 1 percentage point. rM will decrease by 1 percentage point and ri will remain the same. rM will remain the same and ri will decrease by 1 percentage point. Both rM and ri will increase by 1 percentage point. 1. Now assume that rRF remains at 4%, but rM increases to 12%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to one decimal place. The new ri will be %. 2. Now assume that rRF remains at 4%, but rM falls to 10%. The slope of the SML does not remain constant. How would these changes affect ri? Round your answer to one decimal place. The new ri will be %.

Answer 1

1. Required rate of return on Stock i = Risk Free + Beta * (Market Rate - Risk Free)

Required rate of return on Stock i = 4% + 1.50% * (11% - 4%)

Required rate of return on Stock i = 14.50%
Security Market Line = (Market Rate - Risk Free) = 11% - 4% = 7%

2. Now suppose r_RF decreases to 3%. The slope of the SML remains constant. How would this affect r_M and r_i?

when SML is constant

Security Market Line = (Market Rate - Risk Free)

7% = (Market Rate - 3%)

Market Rate = 10%

Required rate of return on Stock i = Risk Free + Beta * (Market Rate - Risk Free)

Required rate of return on Stock i = 3% + 1.50 * 7%

Required rate of return on Stock i = 13.50%

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

3. Now suppose r_RF increases to 5%. The slope of the SML remains constant. How would this affect r_M and r_i?

when SML is constant

Security Market Line = (Market Rate - Risk Free)

7% = (Market Rate - 5%)

Market Rate = 12%

Required rate of return on Stock i = Risk Free + Beta * (Market Rate - Risk Free)

Required rate of return on Stock i = 5% + 1.50 * 7%

Required rate of return on Stock i = 15.50%

Thus, Both r_M and r_i will Increase by 1 percentage point.

4. Now assume that r_RF remains at 4%, but r_M increases 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

Required rate of return on Stock i = Risk Free + Beta * (Market Rate - Risk Free)

Required rate of return on Stock i = 4% + 1.50 * 8%

Required rate of return on Stock i = 16.00%

5. Now assume that r_RF remains at 4%, but r_M falls to 10%. The slope of the SML does not remain constant. How would these changes affect r_i? Round your answer to one decimal place

Required rate of return on Stock i = Risk Free + Beta * (Market Rate - Risk Free)

Required rate of return on Stock i = 4% + 1.50 * 6%

Required rate of return on Stock i = 13.00%