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 rRF = 4%, rM = 8%, and bUT = 1.2.

a. Under current conditions, what is rUT, the required rate of return on UT Stock? Round your answer to two decimal places.

1. Now suppose rRF increases to 5%. The slope of the SML remains constant. How would this affect rM and rUT?

I. rM will remain the same and rUT will increase by 1%. II. rM will increase by 1% and rUT will remain the same. III. Both rM and rUT will decrease by 1%. IV. Both rM and rUT will remain the same. V. Both rM and rUT will increase by 1%.

2. Now suppose rRF decreases to 3%. The slope of the SML remains constant. How would this affect rM and rUT?

I. Both rM and rUT will increase by 1%. II. Both rM and rUT will remain the same. III. Both rM and rUT will decrease by 1%. IV. rM will decrease by 1% and rUT will remain the same. V. rM will remain the same and rUT will decrease by 1%.

3. Now assume rRF remains at 4% but rM increases to 10%. The slope of the SML does not remain constant. How would these changes affect rUT?

I. rUT will increase by 2.4%. II. rUT will remain the same. III. rUT will decrease by 2.4%

4. Now assume rRF remains at 4% but rM falls to 7%. The slope of the SML does not remain constant. How would these changes affect rUT?

I. rUT will increase by 1.2%. II. rUT will remain the same. III. rUT will decrease by 1.2%