8-10. Suppose re4.00%, rM-10.0% and b 1.40. +(z11 Le 94 (ID-s)| 9. what is ri, t

Question

8-10. Suppose re4.00%, rM-10.0% and b 1.40. +(z11 Le 94 (ID-s)| 9. what is ri, the required rate of return on Stock i?-a G- Now suppose that rf either: (1) increases to 5%or (2 decreases to 3%. Assume the slope of the SML remains constant, How would this affect rmand r,(the required return of Stock i)? d u D c. Now assume that r remains the same at 4%, but the required return on the market either: (1) increases to 12% or (2) falls to 9%. Hence, assume that slope of the SML does not remain constant. How would these changes affect r? 10 Suppose you won the lottery and had two options (1) receiving a sure $500,000 or (2) taking a gamble in which, at the flip of a coin you receive either $1,000,000 if a heads comes up but receive $0 if a tails comes up. 8-11. a. What is the expected value of the gamble? b. Would you take the sure $500,000 or the gamble? c. If you chose the sure $500,000, are you a risk averter or a risk seeker?

Explanation / Answer

a) Ri = Rf + ( Rm-Rf) * Bi b) i) Ri= 5 + 6 *1.4 b ii) Ri= 3 + 6 *1.4

= 4 + (10-4) * 1.4 = 13.4% = 8.4%

= 12.4% Rm = 11% Rm = 9%

c) i) Ri= 4 + (12-4) *1.4 c ii) Ri= 4 + (9-4) * 1.4

= 15.2% = 11%  

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