are considering investing in four shares in the equity markets and after careful

Question

are considering investing in four shares in the equity markets and after careful alysis, you have decided on Abax Ltd, Baxter Ltd, Crazy Ltd and e expected market return is 13% and the risk-free rate is 8%. You want to the CAPM to estimate the required rate of return for the three shares. The beta for 8. You consideration and an Densa Ltd. Th each share is as follows: Share Abax Ltd Beta 0.33 Baxter Ltd 0.79 1.00 Crazy Ltod Densa Ltd 1.25 (a) What is the required return for investing in each of these shares? (b) If the risk-free rate increases from 8% to 11% i. How would this change the intercept point of the capital market line with the efficiency frontier? i. How would it change the slope of the securities market line? ii. What securities would you prefer in times when interest rates are rising and conversely if interest rates are falling?

Explanation / Answer

Share Beta Abax 0.33 Baxter 0.75 Crazy 1.00 Densa 1.25 Rm 13% Rf 8% Rm-RF 5% a) Required Return Share Beta Re Abax 0.33 9.65% Baxter 0.75 11.75% Crazy 1.00 13.00% Densa 1.25 14.25% b) i) If Risk Free rate increases, then intercept point slides rightwards toward greater standard deviation (risk) ii) The slope of CML would decrease and CML would become flatter iii) In times of rising interest rates, the required return from risky security also goes up to maintain the risk premium So if required return is lesser, we can opt for lesser risky securities also and get same desired return In time of falling rates of interest, we need to take more risk to get the desired return

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