Question

results. 10.4 Suppose that the risk-free rate, RF, was 8 percent and the required rate of return on the market, R(R), was 14 percent. a. Write out the security market line (SML) equation, and explain each term. b.Plot the SML on a sheet of paper. c. Suppose that inflation expectations increase such that the risk- free rate, RF, increases to 10 percent and the required rate of return on the market, R(R), increases to 16 percent. Write out and plot the new SML. d.Return to the original assumptions in this problem. Now, that investors' risk aversion increases and the required suppose rate of return on the market, R(R), increases to 16 percent. (There is no change in the risk-free rate because RF reflects the required rate of return on a riskless investment.) Write out and plot the new SML. M. the Vale Time Tanectsoat S . 10 5 S rl

How do I solve for a?

Answer 1

A) Security market line is the graphical representation of the capital asset pricing model formula.

The equation:-

" Expected return = risk free rate + Beta (market return - risk free rate) "

Risk free rate = it is the rate of return with no risk involved in it.

Beta = it is a measure of systematic risk of the individual stock compared to the market

Market retutn = it is the return of the market

Market risk premium ( market return - risk free rate)

:- it is premium earned for taking risk in the market over and above the risk free rate.

Expected return = it is the required return of the stock needed for it to be fairly valued.