Question

Suppose r_RF = 4%, r_M = 10%, and b_i = 1.8.

2. Now suppose r_RF decreases to 3%. 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 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 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 decrease by 1 percentage point and r_i will remain the same.
   2. r_M will remain the same and r_i will decrease by 1 percentage point.
   3. Both r_M and r_i will increase by 1 percentage point.
   4. Both r_M and r_i will remain the same.
   5. Both r_M and r_i will decrease by 1 percentage point.
3. 1. Now assume that r_RF remains at 4%, but r_M increases 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   %.

   2. Now assume that r_RF remains at 4%, but r_M falls to 9%. 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

Suppose r_RF = 4%, r_M = 10%, and b_i = 1.8.

CAPM Expected Rate of return = Risk Free Rate + Beta * (Market Risk Premium) = 4% + 1.80 * 6% = 14.80%

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

Slope of SML = Market risk Premium = Market Return - Risk Free = 10% - 4% = 6%

New Expected Rate of Return = Risk Free Rate + Beta * (Market Risk Premium)

New Expected Rate of Return = 3% + 1.80 * 6%

New Expected Rate of Return = 13.80% (Reduced by 1%)

New Market Return = Slope of SML + Risk Free Rate = 6% + 3% = 9% (Reduced by 1%)

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

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

CAPM Expected Rate of return = Risk Free Rate + Beta * (Market Risk Premium) = 4% + 1.80 * 6% = 14.80%

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

Slope of SML = Market risk Premium = Market Return - Risk Free = 10% - 4% = 6%

New Expected Rate of Return = Risk Free Rate + Beta * (Market Risk Premium)

New Expected Rate of Return = 5% + 1.80 * 6%

New Expected Rate of Return = 15.80% (Increased by 1%)

New Market Return = Slope of SML + Risk Free Rate = 6% + 5% = 11% (Increased by 1%)

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

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

New Expected Rate of return = Risk Free Rate + Beta * (Market Risk Premium)

New Expected Rate of return = 4% + 1.80 * 7% = 16.60%

Now assume that r_RF remains at 4%, but r_M falls to 9%. The slope of the SML does not remain constant. How would these changes affect r_i? Round your answer to one decimal place.

New Expected Rate of return = Risk Free Rate + Beta * (Market Risk Premium)

New Expected Rate of return = 4% + 1.80 * 5% = 13.00%

Please dont forget to upvote