The following graph plots the current security market line S

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 (Percent 20.0 16.0 12.0 Return on HCsS 4.0 0.0 1.5 2.0 RISK IBeta 0.5 1.0 CAPM Elements Value Risk-free rate (r) 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 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 Tool tip: Mouse over the points on the graph to see their coordinates. REQUIRED RATE OF RETURN Percentl 20 New SML 16 12 0.0 0.4 08 12 16 2.0 RISK IBetal The SML helps determine the risk-aversion level among investors. The higher the level of risk aversion, the the slope of the SML which of the following statements best describes a shift in the SML caused by increased risk aversion O The risk-free rate will decrease. O The risk-free rate will increase. O The risk-free rate wilf remain constant.

Solution

As per rules I will answer the first 4 subparts of the question

1: Risk free rate = 2%

(Point at which the SML intersects the Y axis)

2: Market risk premium= 6%

Require rate= Rf+ Beta*Risk premium

8%= 2%+ 1*RPm

RPm= 8%-2% = 6%

3: Beta= 1

(The slope of SML at which required return is determined)

4: Required rate = 8%

(As per the graph, the required return is marked as 8%)