^Refer^to^the^graph.^An^increaseⁱⁿ^the^Security^Market^Line^from^SML1 ^to^SML2 ^and^an^increaseⁱⁿ^the^average^expected^rate^of^return^of^asset^A^from^Y1 ^to^Y2 ^would^be^explained^by A)arbitrage only. B)a restrictive monetary policy only. C)both arbitrage and a restrictive monetary policy. D)neither arbitrage nor a restrictive monetary policy.

Question

Quizplus · Accepted Answer

The graph shows an increase in the security market line (SML) from SML1 to SML2, indicating a higher expected rate of return for a given level of risk. This can be caused by both arbitrage and a restrictive monetary policy. Arbitrage refers to the act of exploiting price discrepancies in different markets to make a profit. If investors notice that a particular asset is undervalued in one market, they could buy it in that market and sell it in another market where it is overvalued, thereby making a profit. This could result in an increase in demand for the undervalued asset, driving up its price and lowering its expected rate of return. On the other hand, a restrictive monetary policy is one in which a central bank takes measures to reduce the money supply and increase interest rates. This can make it more expensive for investors to borrow money to invest, thereby reducing demand for assets and driving down their prices. This would lead to a higher expected rate of return for the remaining assets, causing the SML to shift upward. Therefore, both these factors can lead to an increase in the SML, making choice C the correct answer.

Refer to the graph

^Refer^to^the^graph