12. The Capital Asset Pricing Model and the security Market Line Keith holds a portfolio that is invested equally in three stocks (va wn wi 1va). Each stock is described in the following table: Stock Beta Standard Deviation Expected Return DET 0.7 25% AIL 1.0 38% 10.0% 34% INO 1.6 13.5% An analyst has used market- and firm-specific information to make expected return estimates for each stock. The analyst's expected return estimates may or may not equal the stocks' required returns. The risk free rate trRe] is 6%, and the market risk premium IRPN] is 4%. Use the following graph with the security market line (SML) to plot each stock s beta and expected return. Tool tip: Mouse over the points on the graph to see their coordinates. RATE OF RETURNIPerventU Stock OCT RISK Belal A stock is in equilibrium if its required return its expected return. In general, assume that markets and stocks are in equilibrium Cor fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either undervalued or overvalued). Based on the analyst's expected return estimates, stock INO is Stock AIL is in eQuilibrium, and stock DET is 13- Changes to the Security Market Line The following graph plots the current SML and indicates the return that investors require from holding stock from Happy Corp. CHC) Based on the graph, complete the table that follows. RISK [Beta) Risk-free rate CrRe) 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 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model CCAPM). The following graph plots the current SML. Calculate Happy Corp.'s new required return. Then, on the graph, usc 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- The SML helps determine the level of risk aversion among investors. The steeper the slope of the SML. the the level of risk aversion