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 investment’s 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-
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?