REQUIRED RATE OF RETURN Suppose r RF = 3%, r M = 10%, and b i = 1.8. What is r i
ID: 2780976 • Letter: R
Question
REQUIRED RATE OF RETURN
Suppose rRF = 3%, rM = 10%, and bi = 1.8.
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?
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%.
Both rM and ri will remain the same.
Both rM and ri will increase by 1%.
2. Now suppose rRF decreases to 2%. The slope of the SML remains constant. How would this affect rM and ri?
rM will decrease by 1% and ri will remain the same.
rM will remain the same and ri will decrease by 1%.
Both rM and ri will increase by 1%.
Both rM and ri will remain the same.
Both rM 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 %.
Explanation / Answer
Market return = 10%, Risk free rate = 3%, beta = 1.8.
we have to calculate risk premium = 1.8*7 = 12.6
RRR = Risk free rate+ risk premium = 3+12.6 = 15.6%
1. If rRF increases to 4% then Both rM and ri will increase by 1%.
2. If rRF decreases to 2% then Both rM and ri will decrease by 1%.
1. If rM increases to 11% then
Risk premium = (rM-rRF)* beta = (11-3)*1.8 = 14.4
RRR= RP + rRF = 14.4+3 = 17.4%
2. If rM falls to 9% then,
Risk premium = (rM-rRF)* beta = (9-3)*1.8 = 10.8
RRR= RP + rRF = 10.8+3 = 13.8%
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