Calculate \"r\" the rquired rate of return for each of the following. a. Assume

Question

Calculate "r" the rquired rate of return for each of the following.

a. Assume beta is 1.3 for this and the next two problems, the risk-free rate is 6.5%, and market risk is 10.5%.

b. Now assume the risk-free rate increases to 8% because inflation is expected to increase next year.

What will happen to the slope of the SML? Steeper, flatter, or remains constant? Pivots up, pivots down, shifts up, or shifts down?

c. Now assume the investors are more averse to risk in the market and require an additional 1%. The risk-free rat eis 6.5%.

d. What will happen to the slope of the SML? Steeper, flatter, or remains constant? Pivots up, pivots down, shifts up, or shifts down?

Explanation / Answer

a As per CAPM, rate is calculated as R = Risk Free rate of return + Market Risk *Beta = 6.5% + 10.5% * 1.3 = 20.15% b Risk Free Rate Increases to 8% r = 8% + 10.5% *1.3 = 21.65% Since, r has increased by same amount as the increase in Risk free rate, this means that there has been shift up of SML line c Risk Free Rate Increases to 7.5% r = 7.5% + 10.5% *1.3 = 21.15% Since, r has increased by same amount as the increase in Risk free rate, this means that there has been shift up of SML line

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