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 IPercent) 20.0 16.0 12.0 Return on HC's Stock 8.0 4.0 2.0 1,0 1.5 0.5 0.0 RISK 1Betal Value CAPM Elements Risk-free rate (rR) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp, stock ssets 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

Answer 1

Risk-Free Rate (Rf)= Real Interest Rate + Inflation

Required Return= Rf+ Beta * Market Risk Premium ( CAPM Model)

From the Graph: Required Return On HC stock is 8%

if inflation increases by 3% Rf=Rf+3%

Required Rate= Initial Required Rate + 3%

Therefore answer to the first part is 11%

Part 2) The answer is lower. As if the slope is steeper for a change in Risk, the investors want a low premium. That means investors are ready to take the risk or in other words have less aversion to risk

Part 3)

The higher the beta the bigger will be the change in required return of stock as the equation is

Required Return =Rf+ Beta* MRP

so if MRP changer if Beta is higher the required return will be high