Question

Suppose r_RF = 4%, r_M = 11%, and b_i = 2.2.

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

2. 1. Now suppose r_RF increases to 5%. 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%.
   2. r_M will increase by 1% and r_i will remain the same.
   3. Both r_M and r_i will decrease by 1%.
   4. Both r_M and r_i will remain the same.
   5. Both r_M and r_i will increase by 1%.

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

1. 
   
2. 1. Both r_M and r_i will remain the same.
   2. Both r_M and r_i will decrease by 1%.
   3. r_M will decrease by 1% and r_i will remain the same.
   4. r_M will remain the same and r_i will decrease by 1%.
   5. Both r_M and r_i will increase by 1%.

1. 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 two decimal places.

1. The new r_i will be   %.

   2. 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 two decimal places.

   The new r_i will be   %.

Answer 1

Suppose r_RF = 4%, r_M = 11%, and b_i = 2.2.

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

Expected Return = Risk Free Rate + Beta * (Market Rate - Risk Free)

Expected Return = 4% + 2.20 * (11% - 4%)

Expected Return = 19.40%

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

Both r_M and r_i will increase by 1%.

When Risk free rate increases both market rate and risk free rate increases by 1% if slope is constant

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

Both r_M and r_i will decrease by 1%.

When Risk free rate decreases both market rate and risk free rate decreases by 1% if slope is constant

1. 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 two decimal places.

Expected Return = Risk Free Rate + Beta * (Market Rate - Risk Free)

Expected Return = 4% + 2.20 * (12% - 4%)

Expected Return = 21.60%

2. 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 two decimal places.

Expected Return = Risk Free Rate + Beta * (Market Rate - Risk Free)

Expected Return = 4% + 2.20 * (10% - 4%)

Expected Return = 17.20%