Question

Suppose rrf = 9%, rm = 14%, and bi= 1.3

Answer 1

rrf = 9%

rm = 14%

and bi= 1.3

 a.what is ri, the required rate of return on stock i?

The answer is “15.5%”.

This is how we calculate and find the value of ri;

Ri= (rrf + (rm– rrf)bi

Now put the values of rrf,rm and bi;

  = (9% + (14% -09%)1.3

= 15.5%  

b.now suppose that rrf (1) increases to 10% or (2) decreases to 8%. the slope of the sml remains constant. how would this affect rm and ri?

1) Ri = (rrf + (rm – rrf)bi

rm increases by 1% from 14 to15% Rm

rrf increases to10%
 = 10% + (15% - 10%)(1.3)

Ri = 16.5%

 2) Ri = (rrf + (rm – rrf)bi

Rm decreases to 1% from 14 to13%Rm

rrf decreases to 8% from 10 to8%

= 10% + (13% - 8%)(1.3)

Ri = 14.5%


c.now assume that rrf remains at 9% but rm (1) increases to 16% or (2) falls to 13%. the slope of the sml does not remain constant. how would these changes affect ri?

 1) ri = rrf +(rm – rrf)bi

Rm increases to16%

= 9% + (16% - 9%)(1.3)

Ri = 18.10%   

2) ri = rrf +(rm– rrf)bi

Rm decreases to13%

= 9% + (13% - 9%)(1.3)

Ri = 14.2%