The expected rates of return and the beta coefficients of the alternatives as supplied by the bank's computer program are in the attached picture.

1.What is a beta coefficient, and how are betas used in risk analysis?

- Do the expected returns appear to be related to each alternative's market risk?

- Is it possible to choose among the alternatives on the basis of the information developed thus far? Use the data given at the beginning of the problem to construct a graph that shows how the T-bill's, High Tech's, and Collections' beta coefficients are calculated. Discuss what beta measures and explain how it is used in risk analysis.

2. Write out the SML equation, use it to calculate the required rate of retur on each alternative, and then graph the relationship between the expected and required rates of return.

- How do the expected

rates of return compare with the required rates of return?

- Does the fact that Collections has a negative beta coefficient make any sense? What is the implication of the negative beta?

- What would be the market risk and the required return of a 50-50 portfolio of High Tech and Collections? Of a 50-50

portfolio of High Tech and U.S. Rubber?

3. Suppose investors raised their inflation expectations by three percentage points over current estimates as reflected in the 8% T-bill rate. What effect would higher inflation have on the SML and on the returns required on high- and low-risk securities?

- Suppose instead that investors' risk aversion increased enough to cause the market risk premium to increase by three percentage points. (Inflation remains constant) what effect would this change have on the SML and on returns of high- and low risk securities?

SecurityHighTechMarketU.S.RubberT-billsCollectionsReturn(r^)17.4%15.013.88.01.7Risk()1.291.000.680.000.86