Question
Currently under consideration is an investment with a beta, b, of 1.50. At this time, the risk-free rate of return, RF , is 7%, and
Currently under consideration is an investment with a beta, b, of 1.50. At this time, the risk-free rate of return, RF
, is 7%, and the return on the market portfolio of assets, rm, is 10%. You believe that this investment will earn an annual rate of return of 11%. a. If the return on the market portfolio were to increase by 10%, what would you expect to happen to the investments return? What if the market return were to decline by 10%?
b. Use the capital asset pricing model (CAPM) to find the required return on this in- vestment.
c. On the basis of your calculation in part b, would you recommend this invest- ment? Why or why not?
d. Assume that as a result of investors becoming less risk averse, the market return drops by 1% to 9%. What effect would this change have on your responses in parts b and c?
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