Example continued In the above example, now suppose the risk-free rate increases to 6%. Assuming the slope of the SML (= r_M - r_RF) remains rhe same at 9%, how would this affect r_M and r_i ?

Now, new r_RF = 6%, and the slope of the SML remains the same. I.e., r_M - r_RF = 9%. Therefore, new r_M must be 9 + 6 = 15%.

Using the SML, the expected return on a security with beta = 0.8 is 13.2% as is shown in the next:

r_i = r_RF + i (r_M - r_RF) = 6 + (0.8) (15 - 6) = 13.2%

Since he slope remains the same, the SML shifts in a parallel fashion as is shown in the next graph.

Go to the Discussion Board and enter your responses to the following question before you go any further.

Class Discussion Question If there is a security with a negative beta, for example -0.5, what can you say about the expected return of the security based on the Capital Asset Pricing Model (CAPM), or the Security Market Line (SML)? Would it be greater or smaller than the risk-free interest rate? How can you explain your answer intuitively?