Question

need help doing the New SML line on the graph

Ch 08: Assignment - Risk and Rates of Return 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: REQURED RATE OF RETURN(Percent) m elum on HC's Stock RISK (Beta)

Answer 1

Earlier RP_M = R_m - R_F = 6%

Hence, earlier, R_m = 6% + R_F = 6% + 2% = 8%

When inflation comes in picture:

• New Rf = Old Rf + inflation = 2% + 3% = 5%
• New Rm = Old Rm + inflation = 8% + 3% = 11%

The new SML will thus be a line parallel to the old SML but at a distance of 3%. You can see the green line in the diagram below. That's the new SML.

Ch 08: Assignment - Risk and Rates of Return New SML REQUIRED RATE OF RETURN(Percent) 08 1.0 12 RSK (Beta)