The Security Market Line (SML)relates risk to return, for a given set of market conditions. If risk aversion increases, which of the following would most likely occur?
A)The market risk premium would increase.
B)The risk-free rate would increase.
C)The slope of the SML would increase.
D)Both a & c
E)All of the above

Question

Quizplus · Accepted Answer

If risk aversion increases, investors will demand a higher return for taking on additional risk. This will cause the market risk premium (the difference between the expected market return and the risk-free rate) to increase, as investors will require a greater reward for holding risky assets. Additionally, the slope of the Security Market Line (SML) would steepen, since the SML shows the relationship between risk and return, and a higher risk aversion means investors demand a higher return for taking on risk. Therefore, the correct answer is D - Both a & c.

The Security Market Line (SML)relates Risk to Return, for a Given