The following graph plots the current security market line (SML) and indicates t

Question

The following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows REQUIRED RATE OF RETURN (Percent 20.0 16.0 12.0 Return orn HC's Stock 4.0 1.0 1.5 2.0 RISK (Beta) 0.0 0.5 CAPM Elements Value Risk-free rate (rRF) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp. stock An analyst believes that inflation is going to increase by 3.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML. Calculate Happy Corp.'s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst's prediction. Happy Corp.'s new required rate of return is

Explanation / Answer

As we can see from graph:
Risk free rate = 2%
market risk premium is where beta is 1. Market risk premium = 8-2=6%
Beta = 0.6, Place your cursor on the point where Happy Corp. stock intersects the SML. The horizontal coordinate Is the beta, which is 0.6,

The vertical coordinate is the required return from the stock, which is 7.6%

New required return = 5+(0.6*6)=9.6% Beta wont change due to inflation change

Higher risk aversion, higher/greater the slope

High beta stocks will see most change

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