Question 2:Assume that the risk-free rate, RF, is currently 8%, the market return, RM, is 12%, and asset A has a beta, of 1.10. (could be done on word document or excel).Draw the security market line (SML)Use the CAPM to calculate the required return, on asset A.Assume that as a result of recent economic events, inflationary expectations have declined by 3%, lowering RF and RM to 5% and 9%, respectively. Draw the new SML on the axes in part a, and calculate and show the new required return for asset A. Step 1Security market line (SML) is a graphical representation of how the approach of the capital asset pricing model (CAPM) operates. SML represents the combination of risk-free return, market return, and beta to depict the expected return of the security. CAPM is a financial approach that helps to determine the expected return of security by creating a relationship between the systematic risk associated with the security and returns of assets. Expected return on a stock is the minimum amount of return in the form of profit an investor of a company expects from the company over a period of holding the security.Note: Since you have posted a question with multiple sub-parts, we will solve first three sub-parts for you. To get remaining sub-part solved pleased repost the complete question and mention the sub-parts to be solved.arrow_forwardStep 2The major components that help in plotting the security market line for security are risk-free rate, market return, and a beta of the security. A risk-free is the rate of return associated with the investment securities having zero (or very little) risk of default.Beta coefficient is the total volatility that security has with respect to the overall market, that is, how much a security will be volatile in generating returns with respect to the market index. Market return refers to the expected return of the market containing all possible investment schemes available in the financial market as a whole.Part a :In the given scenario, the risk-free rate is 8%, the market return is 12% and the beta of the stock is 1.10. The SML for the stock will be :arrow_forwardStep 3Part b :We can determine the expected return of the stock by using the CAPM approach in the following manner :E(rA)===Rf+[β×(Rm−Rf)]8%+[1.10×(12%−8%)]0.124 or 12.4%ErA=Rf+β×Rm-Rf=8%+1.10×12%-8%=0.124 or 12.4%Where,The risk-free rate (Rf) is 8%Market return (Rm) is 12%The beta coefficient is 1.10Thus, the expected return of the stock will be 12.4%.The security market line (SML) for 12.4% return will be :arrow_forwardStep 4Part c :Due to economic factors, there have been changes in the risk0-free return and the market return. This change in the returns could affect the overall expected return of the stock. The calculation of the expected return of stock after changes is as follows :New E(rA)=Rf +[β×(Rm−Rf)]= 5%+[1.10×(9%−5%)]= 0.094 or 9.4%Where,The risk-free rate (Rf) is 5%Market return (Rm) is 9%The beta coefficient is 1.10Thus, the new expected return of the stock will be 9.4%.The security market line (SML) for 9.4% return will be : Q: Assume that as a result of recent events, investors have become more risk averse, causing the market return to rise by 2%, to be14%. Ignoring the shift in part c, draw the new SML on the same set of axes that you used before, and calculate and show the new required return for asset A.From the previous changes, what conclusions can be drawn about the impact of (1) decreased inflationary expectations and (2) increased risk aversion on the required returns of risky assets?

Question

Question 2:Assume that the risk-free rate, RF, is currently 8%, the market return, RM, is 12%, and asset A has a beta, of 1.10. (could be done on word document or excel).Draw the security market line (SML)Use the CAPM to calculate the required return, on asset A.Assume that as a result of recent economic events, inflationary expectations have declined by 3%, lowering RF and RM to 5% and 9%, respectively. Draw the new SML on the axes in part a, and calculate and show the new required return for asset A. Step 1Security market line (SML) is a graphical representation of how the approach of the capital asset pricing model (CAPM) operates. SML represents the combination of risk-free return, market return, and beta to depict the expected return of the security. CAPM is a financial approach that helps to determine the expected return of security by creating a relationship between the systematic risk associated with the security and returns of assets. Expected return on a stock is the minimum amount of return in the form of profit an investor of a company expects from the company over a period of holding the security.Note: Since you have posted a question with multiple sub-parts, we will solve first three sub-parts for you. To get remaining sub-part solved pleased repost the complete question and mention the sub-parts to be solved.arrow_forwardStep 2The major components that help in plotting the security market line for security are risk-free rate, market return, and a beta of the security. A risk-free is the rate of return associated with the investment securities having zero (or very little) risk of default.Beta coefficient is the total volatility that security has with respect to the overall market, that is, how much a security will be volatile in generating returns with respect to the market index. Market return refers to the expected return of the market containing all possible investment schemes available in the financial market as a whole.Part a :In the given scenario, the risk-free rate is 8%, the market return is 12% and the beta of the stock is 1.10. The SML for the stock will be :arrow_forwardStep 3Part b :We can determine the expected return of the stock by using the CAPM approach in the following manner :E(rA)===Rf+[β×(Rm−Rf)]8%+[1.10×(12%−8%)]0.124 or 12.4%ErA=Rf+β×Rm-Rf=8%+1.10×12%-8%=0.124 or 12.4%Where,The risk-free rate (Rf) is 8%Market return (Rm) is 12%The beta coefficient is 1.10Thus, the expected return of the stock will be 12.4%.The security market line (SML) for 12.4% return will be :arrow_forwardStep 4Part c :Due to economic factors, there have been changes in the risk0-free return and the market return. This change in the returns could affect the overall expected return of the stock. The calculation of the expected return of stock after changes is as follows :New E(rA)=Rf +[β×(Rm−Rf)]= 5%+[1.10×(9%−5%)]= 0.094 or 9.4%Where,The risk-free rate (Rf) is 5%Market return (Rm) is 9%The beta coefficient is 1.10Thus, the new expected return of the stock will be 9.4%.The security market line (SML) for 9.4% return will be :  Q: Assume that as a result of recent events, investors have become more risk averse, causing the market return to rise by 2%, to be14%. Ignoring the shift in part c, draw the new SML on the same set of axes that you used before, and calculate and show the new required return for asset A.From the previous changes, what conclusions can be drawn about the impact of (1) decreased inflationary expectations and (2) increased risk aversion on the required returns of risky assets?

Accepted Answer

SML means security market line.
CAPM means capital asset pricing model.