Suppose rRF = 8%, rM = 13%, and bi = 1.6. What is ri, the required rate of retur

Question

Suppose rRF = 8%, rM = 13%, and bi = 1.6. What is ri, the required rate of return on Stock i? Round your answer to two decimal places. 1. Now assume that rRF remains at 8%, but rM increases to 14%. 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 8%, but rM falls to 12%. 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

ri = rRF + (rM - rRF) x bi

where,

ri = Required rate of return on stock i

rRF = Risk free return = 8%

rM = Market rate of return = 13%

bi = beta of stock = 1.6

ri = rRF + (rM - rRF) x bi

= 8% + (13% - 8%) x 1.6

= 8% + 8%

= 16%

1.

rRF = 8%

rM = 14%

bi = 1.6

ri = rRF + (rM - rRF) x bi

= 8% + (14% - 8%) x 1.6

= 8% + 9.6%

= 17.6%

2.

rRF = 8%

rM = 12%

bi = 1.6

ri = rRF + (rM - rRF) x bi

= 8% + (12% - 8%) x 1.6

= 8% + 6.4%

= 14.4%

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