Required Rate of Return

As an equity analyst you are concerned with what will happen to the required return to Universal Toddler' stock as market conditions change. Suppose r_RF = 7%, r_M = 11%, and b_UT = 1.8.

a. Under current conditions, what is r_UT, the required rate of return on UT Stock? Round your answer to one decimal place. %

b. Now suppose r_RF increases to 8%. The slope of the SML remains constant. How would this affect r_M and r_UT?

I. r_M will remain the same and r_UT will increase by 1 percentage point. II. r_M will increase by 1 percentage point and r_UT will remain the same. III. Both r_M and r_UT will decrease by 1 percentage point. IV. Both r_M and r_UT will remain the same. V. Both r_M and r_UT will increase by 1 percentage point.

c. Now suppose r_RF decreases to 6%. The slope of the SML remains constant. How would this affect r_M and r_UT?

I. Both r_M and r_UT will increase by 1 percentage point. II. Both r_M and r_UT will remain the same. III. Both r_M and r_UT will decrease by 1 percentage point. IV. r_M will decrease by 1 percentage point and r_UT will remain the same. V. r_M will remain the same and r_UT will decrease by 1 percentage point.

d. Now assume r_RF remains at 7% but r_M increases to 13%. The slope of the SML does not remain constant. How would these changes affect r_UT?

I. r_UT will decrease by 3.6 percentage point. II. r_UT will remain the same. III. r_UT will increase by 3.6 percentage point.

e. Now assume r_RF remains at 7% but r_M falls to 10%. The slope of the SML does not remain constant. How would these changes affect r_UT?

I. r_UT will remain the same. II. r_UT will decrease by 1.8 percentage point. III. r_UT will increase by 1.8 percentage point.