blue line slope= 4.50 y-intercept= 5

orange 1.2, 10.4

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 return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analysts prediction.

Happy Corp.s new required rate of return is _____

13.6%

28.5

8.7

12.4

20.0 16.0 12.0 Return on HC's Stock REQUIRED RATE OF RETURN (Percent) 8.0 4.0 0 0 0.5 1.0 1.5 2.0 RISK (Beta) CAPM Elements Value Risk-free rate (TRF) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp. stock New SML 16 12 REQUIRED RATE OF RETURN (Percent) 0 0 0.4 1.6 2.0 0.8 1.2 RISK (Beta) The SML helps determine the level of risk aversion among investors. The higher the level of risk aversion, the the slope of the SML. Which kind of stock is most affected by changes in risk aversion? (In other words, which stocks see the biggest change in their required returns?) O All stocks affected the same, regardless of beta O High-beta stocks O Medium-beta stocks O Low-beta stocks