Answer:
a = 0.74 or 74%
b(1) = 0.75 or 75%
b(2) = 0.73 or 73%
c(1) = 1 or 1%
c(2) = 0.61 or 61%
Explanation:
The stock i has a risk free rate of 9% with a market return of 14% and beta of 13, using the formula we get,
ri = rRF + bi x (rM – rRF)
Where rRF=9/100=0.09
bi =13
rm =14/100=0.14
Putting the values into the formula
= 0.09 + 13 x (0.14 – 0.09)
= 0.74 or 74%
b. (1)
Ri = rRF + bi x (rM – rRF)= 0.10 + 13 x (0.14 – 0.09)= 0.75 or 75%
Here the slope of SML remains constant, meaning the market risk premium will not change. As a result, the required return will increase by 1%.
b(2)
Ri = rRF + bi x (rM – rRF)= 0.08 + 13 X (0.14 – 0.09)= 0.73 or 73%
Here, the slope of SML remains constant, meaning the market risk premium will not change. As a result the required return will decrease by 1%.
c. (1)
Ri = rRF + bi x (rM – rRF)= 0.09 + 13 x (0.16 – 0.09)= 1 or 1%
Here, the slope of SML does not remain constant, meaning the market risk premium will change. As a result, the required return will increase.
(2)Ri = rRF + bi x (rM – rRF)= 0.09 + 13 x (0.13 – 0.09)=0.61 or 61%
Here, the slope of SML remains constant, meaning the market risk premium will not change. As a result, the required return will decrease by 13%.
