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

Question

Quizplus · Accepted Answer

When inflation expectations increase, the risk-free rate increases, causing the Security Market Line (SML) to shift up. If investors become more risk-averse, they require a higher risk premium for taking on additional risk, which increases the slope of the SML.

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