Assignment 08 - Risk and Rates of Return 8. Changes to the security market line 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 Return on 0.0 0.5 10 RISK (Betal Value CAPM Elements Risk free rate (TRE) Market risk premium (RP) Happy Corp. stock's beta Required rate of retum on Happy Corp. stock Assignment 08 - Risk and Rates of Return 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 retum. 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 Tooltip: Mouse over the points on the graph to see their coordinates REQUIRED RATE OF RETURN Percent! New SML Beta The SML helps determine the level of risk aversion among investors. The latter the slope of the SHL, the the level of risk aversion which kind of stock is most affected by changes in risk version (In other words, which stocks see the biggest change in their required returns?) Medium-beta stocks O Low beta stocks High beta stocks As stocks affected the same, regardless of beta