Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Risk and Rates of Return: Security Market Line The security market line (SML) is an equation that shows the relationship between risk as measured by

Risk and Rates of Return: Security Market Line The security market line (SML) is an equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities. The SML equation is given below: If a stock's expected return plots on or above the SML, then the stock's return is to compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is to compensate the investor for risk. The SML line can change due to expected inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses. Quantitative Problem: You are given the following information for Wine and Cork Enterprises (WCE): rRF = 3%; rM = 9%; RPM = 6%, and beta = 1.4 What is WCE's required rate of return? Round your answer to 2 decimal places. Do not round intermediate calculations. % If inflation increases by 3% but there is no change in investors' risk aversion, what is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations. % Assume now that there is no change in inflation, but risk aversion increases by 1%. What is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations. % If inflation increases by 3% and risk aversion increases by 1%, what is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations. %

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Principles Of Corporate Finance

Authors: Richard Brealey

10th Global Edition

0071314172, 9780071314176

More Books

Students also viewed these Finance questions