Question

Suppose rRF = 3%, rM = 10%, and bi = 1.4. What is ri, the required rate of return on Stock i? Round your answer to two decimal places. % 1. Now suppose rRF increases to 4%. The slope of the SML remains constant. How would this affect rM and ri? 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. Both rM and ri will decrease by 1%. 2. Now suppose rRF decreases to 2%. 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 3%, 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 3%, 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

Q: What is ri, the required rate of return on Stock i?

=rRF+bi*(rM-rRF)=3%+1.4*(10%-3%)=12.8%

Slope of SML=10%-3%=7%

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

To keep slope constant when rRF increases, rM has to increase as well. rM will increase by 1%

ri would increase as well. ri would increase by 1%

Both rM and ri will increase by 1%

Q: Now suppose rRF decreases to 2%. The slope of the SML remains constant.

To keep slope constant when rRF decreases, rM has to decrease as well. rM will decrease by 1%

ri would decrease as well. ri would decrease by 1%

Both rM and ri will decrease by 1%

Q: Now assume that rRF remains at 3%, but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect ri?

Slope of SML=11%-3%=8%

ri=3%+1.4*8%=14.20%

Q: Now assume that rRF remains at 3%, but rM falls to 9%. The slope of the SML does not remain constant. How would these changes affect ri?

Slope of SML=9%-3%=6%

ri=3%+1.4*6%=11.40%