What will happen to the Security Market Line if (1) inflation expectations increase and (2) investors become more risk averse?
A) It will shift up and have a steeper slope.
B) It will shift down and have the same slope.
C) It will shift down and have a steeper slope.
D) It will shift up but have less slope.

Question

Quizplus · Accepted Answer

The Security Market Line (SML) represents the expected return of a security or portfolio in relation to its risk (beta). If inflation expectations increase, the expected return on all investments would need to increase to compensate for the higher expected inflation, causing the SML to shift up. If investors become more risk-averse, they would require a higher return for any given level of risk, steepening the slope of the SML.

What Will Happen to the Security Market Line If (1)