Question

1. If the risk-free return were 4.0% and a security's beta coefficient were 2.0, what would be the required rate of return for the security? 4% 5% 10% 14% 2. If the risk-free return (inflation) increases by 2 percentage points, the required rate of return stays the same for all securities increases the same 2 percentage points for all securities increases for some securities and decreases for others depending on the beta coefficient cannot be determined without more information 3. If the risk-free return (inflation) increases by 2 percentage points, then for the security market line both the y-intercept and the slope remain the same the y-intercept changes and the slope remains the same the y-intercept remains the same and the slope changes both the y-intercept and the slope change

Answer 1

Answer:

1. Use CAPM to solve

Required Return = Risk Free Rate + beta(market premium)

= 4% + 2(5%)

= 14%

2. Increases the same 2 percentage points for all securities

If the risk-free return increases by 2%, then it would become 6%.

The required return becomes;

= 6% + 2(5%)

= 16%

Required return increases by 2% to 16%.

3. The y-intercept changes and the slope remains the same.

The formula for the Security Market Line is the CAPM formula.

The normal formula for a line takes the form;

y = mx + c

Where c is the y intercept and m is the slope.

The CAPM formula is the same at;

R = rF + brM

The beta is the slope and the risk free rate is the y intercept. If the risk-free rate increases by 2% then the y-intercept will change by those 2 percentage points but the beta will remain the same.