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A stock lies on SML has an expected return of 10.7% and a beta of .91,...

A stock lies on SML has an expected return of 10.7% and a beta of .91, and the expected return on the market is 11.5%. what is the intercept and slope of sml?

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Answer #1

SML intercept = Risk free rate

SML Slope = Market Risk Premium

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We can find Risk-free rate from CAPM equation:

Return on stock = Risk free rate + Beta x (Market Rate - Risk free rate)

10.7% = Risk free rate + 0.91 x (11.5% - Risk free rate)

Risk free rate - 0.91 x Risk free rate = 10.7% - 0.91x11.5%

Risk free rate = (10.7%-0.91x11.5%)/0.09

Risk free rate = 2.6111%

Hence, intercept of SML = 2.6111%

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Now, we can find slope of the SML = Market risk premium = MRP;

Market risk premium = Market rate - Risk free rate

MRP = 11.5%-2.6111%

MRP = 8.8889%

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Hence slope of SML = 8.8889%

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