Consider again the SML given by Equation 8.18 and shown in Figure 8.15. Assume that the risk-free rate (^rf) of 6 percent is based on an expected inflation premium of 4 percent. Suppose expected inflation increases by two percentage points to 6 percent.
a. Write an equation for the SML given the increase in the expected inflation premium, assuming that all other factors remain constant.
b. Redraw the SML based on the new expected inflation premium.
c. Determine the required rate of return (kj) on Amazon.com common stock before and after the expected increase in inflation. (See Table 8.8 for the appropriate beta.)
Text Book: Contemporary Financial Management By R. Charles Moyer, James McGuigan, Ramesh Rao.