Assume that the Security Market Line (SML)is based on a risk free rate of 5% and a market rate of 11%. What will happen to the SML if the forecast of inflation increases and investors become more risk averse?
A)The SML will shift down and have a steeper slope
B)The SML will shift up and have a less steep slope
C)The SML will shift down and have the same slope
D)The SML will shift down and have a less steep slope
E)The SML will shift up and have a steeper slope

Question

Quizplus · Accepted Answer

An increase in the forecast of inflation typically leads to a higher risk-free rate, causing the SML to shift upwards because the expected return for any level of risk increases. Additionally, if investors become more risk-averse, they will demand a higher return for taking on additional risk, which steepens the slope of the SML. This reflects the increased premium for riskier investments.

Assume That the Security Market Line (SML)is Based on a Risk