Suppose rRF = 8%, rM = 12%, and bi = 1.8. a. What is ri , the required rate of r

Question

Suppose rRF = 8%, rM = 12%, and bi = 1.8.

a. What is ri , the required rate of return on Stock i? Round your answer to two decimal places.
%

b. Now suppose rRF (1) increases to 9%. The slope of the SML remains constant. How would this affect rM and ri ?

I. rM will remain the same and ri will increase by 1%.
II. rM will increase by 1% and ri will remain the same.
III. Both rM and ri will decrease by 1%.
IV.Both rM and ri will remain the same.
V. Both rM and ri will increase by 1%.

c. Now suppose rRF (2) decreases to 7%. The slope of the SML remains constant. How would this affect rM and ri ?

I. Both rM and ri will decrease by 1%.
II. rM will decrease by 1% and ri will remain the same.
III. rM will remain the same and ri will decrease by 1%.
IV. Both rM and ri will increase by 1%.
V. Both rM and ri will remain the same.

Explanation / Answer

a) Ri = Rf + Beta( Rm-Rf) = 15.2 % b) Slope of SML is Rm -Rf. Therefore, RM will increase by 1% to keep the slope constant, and Ri will increase by 1% also. Refer to formula used in a) c) Likwise, Rm and Ri both will decrease by 1%, for Rf decreasing by 1% and slope remaining constant

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