Question
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
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 = 7%; RPM = 4%, and beta = 1
What is WCE's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places.
%
If inflation increases by 3% but there is no change in investors' risk aversion, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.
%
Assume now that there is no change in inflation, but risk aversion increases by 1%. What is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.
%
If inflation increases by 3% and risk aversion increases by 1%, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.
%
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