Question

Suppose r_RF = 6%, r_M = 12%, and b_i = 1.7.

2. Now suppose r_RF decreases to 5%. 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 7%. 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-IIIIIIIVVItem 2

   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 6%, but r_M increases to 13%. 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 6%, but r_M falls 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   %.

Answer 1

rrf = 6%

rm = 12%

and bi= 1.7

a.what is ri, the required rate of return on stock i?

The answer is “16.2%”.

This is how we calculate and find the value of ri;

Ri= (rrf + (rm– rrf)bi

Now put the values of rrf,rm and bi;

= (6% + (12% -6%)1.7

= 16.2%  

b.1 Now suppose r_RF decreases to 5%. The slope of the SML remains constant. How would this affect r_M and r_i?

1) Ri = (rrf + (rm – rrf)bi

rm decreases by 1% from 12 to11% Rm

ri will remain same
= 6% + (11% - 5%)(1.7)

Ri = 16.2%

r_M will decrease by 1 percentage point and r_i will remain the same

2.Now suppose r_RF increases to 7%. The slope of the SML remains constant. How would this affect r_M and r_i?

1) Ri = (rrf + (rm – rrf)bi

rm increases by 1% from 12 to13% Rm

ri will remain same
= 6% + (13% - 7%)(1.7)

Ri = 16.2%

r_M will increase by 1 percentage point and r_i will remain the same.

c.

1) ri = rrf +(rm – rrf)bi

Rm increases to13%

= 6% + (13% - 6%)(1.7)

Ri = 17.9%

2) ri = rrf +(rm– rrf)bi

Rm decreases to11%

= 6% + (11% - 6%)(1.7)

Ri = 14.5%