# Question

Assume that you expect the economy’s rate of inflation to be 3 percent, giving an RFR of

6 percent and a market return (RM) of 12 percent.

a. Draw the SML under these assumptions.

b. Subsequently, you expect the rate of inflation to increase from 3 percent to 6 percent.

What effect would this have on the RFR and the RM? Draw another SML on the graph from Part a.

c. Draw an SML on the same graph to reflect an RFR of 9 percent and an RM of 17 percent.

How does this SML differ from that derived in Part b? Explain what has transpired.

6 percent and a market return (RM) of 12 percent.

a. Draw the SML under these assumptions.

b. Subsequently, you expect the rate of inflation to increase from 3 percent to 6 percent.

What effect would this have on the RFR and the RM? Draw another SML on the graph from Part a.

c. Draw an SML on the same graph to reflect an RFR of 9 percent and an RM of 17 percent.

How does this SML differ from that derived in Part b? Explain what has transpired.

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