AmbleBros Company creates smart shoes with an app that connects to the users phone. As part of your portfolio analysis project, you are estimating your required rate of return on an investment in AmbleBros using the Securities Market Line (SML).

You have looked up the current risk-free rate of return, which is 4.6%. Given the numerous disruptive events going on in the world and in the markets, you estimate the market risk premium to be 6.5%. AmbleBros most recent beta estimate is 1.76.

Required:

a. Show calculations for AmbleBros required rate of return given this information.

Calculation of AmbleBros' required rate of return:

Required rate of return = Risk-free rate + Beta * (Market risk premium)

Required rate of return = 4.6% + 1.76 * 6.5%

Required rate of return = 4.6% + 11.44%

Required rate of return = 16.04%

Therefore, AmbleBros' required rate of return is 16.04%.

b. Explain in your own words how the SML would change if the risk-free rate were to rise to 7%. Describe the SMLs change in terms of the y-intercept and the slope.

If the risk-free rate were to rise to 7%, the SML would shift upwards. The y-intercept of the SML would increase, reflecting the higher risk-free rate. The slope of the SML would remain unchanged because the change in the risk-free rate does not affect the market risk premium or beta. As a result, the required rate of return for any given level of risk would increase.

c. Independent of the change in part b, explain in your own words how the SML would change if the market risk premium fell to 3.5%.

If the market risk premium fell to 3.5%, the SML would shift downwards. The y-intercept of the SML would remain unchanged, reflecting the risk-free rate. However, the slope of the SML would decrease, as the market risk premium is in the numerator of the equation. As a result, the required rate of return for any given level of risk would decrease.

d. If AmbleBros beta dropped to 0.88 six months from now, would its required rate of return rise or fall? Explain.

If AmbleBros' beta dropped to 0.88 six months from now, its required rate of return would fall. This is because the required rate of return is directly proportional to beta, meaning that a decrease in beta would result in a decrease in the required rate of return. Assuming that the risk-free rate and market risk premium remain the same, the new required rate of return would be:

New required rate of return = 4.6% + 0.88 * 6.5%

New required rate of return = 9.028%

Therefore, AmbleBros' required rate of return would fall to 9.028%.