Answer Happy

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. REQUIRED RATE OF RETURN (Percent) 20.0 16.0 12.0 8.0 Return on HC's Stock 0.5 1.0 RISK (Beta) CAPM Elements Risk-free rate (TRF) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp. stock 1.5 Value Happy Corp.'s new required rate of return is 2.0 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 analyst's prediction. Tool tip: Mouse over the points in the graph to see their coordinates.

REQUIRED RATE OF RETURN (Percent) 20 16 0 0 0.4 0.8 1.2 O Medium-beta stocks O High-beta stocks O Low-beta stocks RISK (Beta) 1.6 2.0 —▬▬ The SML helps determine the level of risk aversion among investors. The higher the level of risk aversion, the O All stocks affected the same, regardless of betal New 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?) the slope of the SML.