$11.$ 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:

$0$

$0\mathrm{.}5$

$1\mathrm{.}0$

$1\mathrm{.}5$

$2\mathrm{.}0$

$20\mathrm{.}0$

$16\mathrm{.}0$

$12\mathrm{.}0$

$8\mathrm{.}0$

$4\mathrm{.}0$

$0$

REQUIRED RATE OF RETURN $($Percent$)$

RISK $($Beta$)$

Return on HC$\text{'}$s Stock

$0\mathrm{.}6,7\mathrm{.}6$

Y$-$Intercept: $4\mathrm{.}00$

Slope: $6$

CAPM Elements

Value

Risk$-$free rate $($rRF

$)2\mathrm{.}2\%$

Market risk premium $($RPM

$)$

Happy Corp. stock$$s beta $1\mathrm{.}0$

Required rate of return on Happy Corp. stock

An analyst believes that inflation is going to increase by $2\mathrm{.}0\%$ 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.

New SML

$0$

$0\mathrm{.}4$

$0\mathrm{.}8$

$1\mathrm{.}2$

$1\mathrm{.}6$

$2\mathrm{.}0$

$20$

$16$

$12$

$8$

$4$

$0$

REQUIRED RATE OF RETURN $($Percent$)$

RISK $($Beta$)$

Y$-$Intercept: $16$

Slope: $0$

The SML helps determine the risk$-$aversion level among investors. The steeper the slope of the SML$,$ the the level of risk aversion.

Which of the following statements best describes a shift in the SML caused by increased risk aversion?

The risk$-$free rate will decrease.

The risk$-$free rate will increase.

The risk$-$free rate will remain constant.