Question

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AaBbCcDc AaBbCcDc AaBb 1 Normal T No Spac... Heading 1 AaBbc Heading 2 A ==== E, C, E, Styles Paragraph 6. What happens to the SML graph if inflation changes or if risk aversion changes? How will this impact the required returns of stocks with a beta of 0.5, 1.0, or 1.5, respectively? (You do not need to provide calculations on this, but explain what happens.) 5 points

Answer 1

1. Impact on the required rate of return due to change in inflation:
a. If the inflation goes up, the required rate of return increases because of the Rf & Rm increase.
"There is an upward parallel shift in the SML"

b. If the inflation goes down, the required rate of return decreases because the Rf & Rm decreases.

"There is a downward parallel shift in the SML"

2. If the investor becomes more risk-averse, then market risk premium increases- Then the required rate of return increases.
"The SML line becomes steeper as the risk aversion increases"

Note: I have taken an example to showcase the impact on the required rate of return due to change in inflation or risk aversion in the notes.

As you can see the notes.
Even if you substitute the beta with 0.5,1 or 1.5 the impact remains in the same direction. However, the magnitude of the impact is different.

Stock with a beta of 0.5 has less magnitude of impact, where are stock with a beta of 1.5 has the largest magnitude of impact.

Ex:- Yeild on Government securities = 6% (Rp) will to Expected fetarnon Market portfolio =15% (RM) Q1: Show the equation of SmL; also draw a graph, Q2: If inflation premium goes up by 1%, show the - New SmL. Q3: if investors become more risk treuse such that market siste premium goes up by 10% of the existing level, show the Newsmil l al inte Qur- What if we have a combination of 2&3. Soli- Rp 6% Refp.pt & m= 15% Rm - 4 Rm-Rf- 90% Re- RF+ (Rm-ff) ß. [Re= 6+98] LA SML 1541 Agressine sto defensive Stocks B시 B>,

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