Question

REQUIRED RATE OF RETURN

Suppose rRF = 6%, rM = 13%, and bi = 1.7.

2. Now suppose rRF decreases to 5%. The slope of the SML remains constant. How would this affect rMand ri?

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

1. Now suppose rRF increases to 7%. The slope of the SML remains constant. How would this affect rMand ri?

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.

Both rM and ri will decrease by 1%.

Both rM and ri will remain the same.

-Select-IIIIIIIVVItem 2  

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

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.

-Select-IIIIIIIVVItem 3  

1. Now assume that rRF remains at 6%, but rM increases to 14%. 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 6%, but rM falls to 12%. 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

required return on stock by the CAPM equation is

Es = rf + Bi(Emkt - rf) = 17.9%. Now if rRF increases to 7% then to keep the slope of SML constant the market return should increase by 1% and this will also increase the return on security by 1%. So Both rM and ri will increase by 1%. Now if rRF decreases to 5% then to keep slope of SML constant the market return should decrease by 1% and this will also decrease the return on security by 1%. So Both rM and ri will decrease by 1%. Now if rRF remains at 6%, but rM increases to 14% and the slope of the SML does not remain constant. Then ri will increase and can be calculated likely as we calculated above using CAPM. The  new ri = 19.60%. Now if rRF remains at 6%, but rM falls to 12% and slope of the SML does not remain constant. Then ri will decrease and can be calculated likely as we calculated above using CAPM. The  new ri = 16.20%