13. 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. REQUIRED RATE OF RETURN (Percent) REQUIRED RATE OF RETURN (Percent) 20.0 16.0 20 12.0 16 8.0 12 4.0 0 0 CAPM Elements Risk-free rate (TRF) Market risk premium (RPM) Happy Corp. stock's betal Required rate of return on Happy Corp. stock 0 Happy Corp.'s new required rate of return is F 0.6, 7.6 HC's Stock ☐ 0.5 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. 0 1.0 RISK (Beta) Tool tip: Mouse over the points in the graph to see their coordinates. 0.4 0.8 1.5 1.2 Value RISK (Beta) 1.6 2.0 2.0 (?) O All stocks affected the same, regardless of beta O High-beta stocks O Low-beta stocks O Medium-beta stocks New SML (?) 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?)
13. 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. REQUIRED RATE OF RETURN (Percent) REQUIRED RATE OF RETURN (Percent) 20.0 16.0 20 12.0 16 8.0 12 4.0 0 0 CAPM Elements Risk-free rate (TRF) Market risk premium (RPM) Happy Corp. stock's betal Required rate of return on Happy Corp. stock 0 Happy Corp.'s new required rate of return is F 0.6, 7.6 HC's Stock ☐ 0.5 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. 0 1.0 RISK (Beta) Tool tip: Mouse over the points in the graph to see their coordinates. 0.4 0.8 1.5 1.2 Value RISK (Beta) 1.6 2.0 2.0 (?) O All stocks affected the same, regardless of beta O High-beta stocks O Low-beta stocks O Medium-beta stocks New SML (?) 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?)
Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Chapter5: Risk Analysis
Section: Chapter Questions
Problem 11QE: Market equity beta measures the covariability of a firms returns with all shares traded on the...
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Question
Transcribed Image Text:13. 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.
REQUIRED RATE OF RETURN (Percent)
REQUIRED RATE OF RETURN (Percent)
20.0
16.0
20
12.0
16
8.0
12
4.0
0
0
CAPM Elements
Risk-free rate (TRF)
Market risk premium (RPM)
Happy Corp. stock's betal
Required rate of return on Happy Corp. stock
0
Happy Corp.'s new required rate of return is
F 0.6, 7.6
HC's Stock
☐
0.5
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.
0
1.0
RISK (Beta)
Tool tip: Mouse over the points in the graph to see their coordinates.
0.4
0.8
1.5
1.2
Value
RISK (Beta)
1.6
2.0
2.0
(?)
O All stocks affected the same, regardless of beta
O High-beta stocks
O Low-beta stocks
O Medium-beta stocks
New SML
(?)
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?)
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