Question

10. Suppose r_RF = 6%, r_M = 11%, and b_i = 1.3.

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 two decimal places.
   %

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

3. 1. Now assume that r_RF remains at 6%, 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.

   The new r_i will be  %.

   2. Now assume that r_RF remains at 6%, 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

10. Suppose r_RF = 6%, r_M = 11%, and b_i = 1.3.

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

Initially, r_i = r_RF + b_i (r_M - r_RF) = 6% + 1.3 x (11% - 6%) = 12.50%

Now, r_RF decreases to 5%.

The slope of the SML remains constant. This implies r_M - r_RF now = r_M - 5% is same as before = 11% - 6% = 5%

Hence, r_M = 5% + 5% = 10%

And r_i = r_RF + b_i (r_M - r_RF) = 5% + 1.3 x (10% - 5%) = 11.50%

Hence, both r_M and r_i declines by 1% each.

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-Select-IIIIIIIVVItem 3

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

   Initially, r_i = r_RF + b_i (r_M - r_RF) = 6% + 1.3 x (11% - 6%) = 12.50%

   Hence, your answer should be 12.50%

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?

Now, r_RF increases to 7%.

The slope of the SML remains constant. This implies r_M - r_RF now = r_M - 7% is same as before = 11% - 6% = 5%

Hence, r_M = 7% + 5% = 12%

And r_i = r_RF + b_i (r_M - r_RF) = 7% + 1.3 x (12% - 7%) = 13.50%

Hence, both r_M and r_i increases by 1% each.

Hence, the correct answer is option 2. Both r_M and r_i will increase by 1%

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-Select-IIIIIIIVVIte

1. 1. Now assume that r_RF remains at 6%, 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.

   The new r_i will be = r_i = r_RF + b_i (r_M - r_RF) = 6% + 1.3 x (12% - 6%) = 13.80%

Hence, your answer should be 13.80%

1. 2. Now assume that r_RF remains at 6%, 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 = r_i = r_RF + b_i (r_M - r_RF) = 6% + 1.3 x (10% - 6%) = 11.20%

Hence, your answer should be 11.20%