8-12

UIRED RETURN Bradford Manufacturing Company has a beta of 1.45, and Faiey Industries has a beta of 0.85. The required return on an index fund that holds the entire stock market is 12.0%. The risk-free rate of interest is 5%. By how much does Bradford's required return exceed Farley's required return? CAPM AND REQUIRED RETURN Calculate the required rate of return for Manning Enter- 8-1 prises assuming that investors expect a 3.5% rate of inflation in the future. The real risk-free rate is 2.5%, and the market risk premium is 6.5%. Manning has a beta of 1.7, and its realized rate of return has averaged 13.5% over the past 5 years. 1.3 8-12 REQUIRED RATE OF RETURN Suppose rRF-9%, rM 14%, and bi What is ri, the required rate of return on Stock i? a. b. Now suppose that rRF (1) increases to 10% or (2) decreases to 8%. The slope of 4 the SML remains constant. How would this affect rM and r? 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 r? c. CAPM, PORTFOLIO RISK, AND RETURN Consider the following information for Stocks X, Y, and Z. The returns on the three stocks are positively correlated, but they are not perfectly 8-13 correlated. (That is, each of the correlation coefficients is between 0 and 1.) Stock Expected Return Standard Deviation Beta 0.8 1.2 1.6 15% 15 15 10.75 12.50