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:

CAPM Elements

Value

Risk$-$free rate $(r_{RF})$

Market risk premium $(R{P}_M)$

Happy Corp. stock's beta

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.$\text{'}$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.$\text{'}$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 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 the shape of the SML if investors were not at all risk averse?

The SML would have a positive slope, but the slope would be flatter than it would be if investors were risk averse.

The SML would be a horizontal line.

The SML would have a positive slope, but the slope would be steeper than it would be if investors were risk averse.

The SML would have a negative slope.