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 Return on HC's Stork 12.0 8.0 40 0.0 0.5 1.0 1.5 2.0 RISK IBetal CAPM Elements Value Risk-free rate (rep) 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 2.0 % 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 returm. 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 ret urn is Tool tip: Mouse over the points on the graph to see their coordinates.

Answer 1

Ques 1
risk free rate - 5%
market risk premium-4.5%
happy corp stock beta-1.2
required rate of rturn-10.4%

explanation:
the risk free rate is the vertical intercept of the SML line and the marjet risk premium is the slope of SML line

to fine the risk free rate place your cursor on the point on the vertical axis
for market risk premium roll your cursor over the SML
on the intercsection the horizontal cordinate(1.2) gives you beta and vertical (10.4%) is required rate of return

Ques 2
the risk free rate consists of to elements :a risk free rate of return and inflation premium. when inflation increases by 2% the SML will shift vertically and new Rf=7%

Rm=Rf + Beta (Risk premium)
Rm=7%+1.2*(4.5%)
Rm=12.40%