In the capital asset pricing model, an increase in inflationary expectations will be reflected by ________.
A) no effect on security market line
B) a decrease in the slope of the security market line
C) a parallel shift downward in the security market line
D) a parallel shift upward in the security market line

Question

Quizplus · Accepted Answer

An increase in inflationary expectations generally leads to an increase in the risk-free rate, as lenders demand higher returns to compensate for the decreased purchasing power of future cash flows. In the Capital Asset Pricing Model (CAPM), the risk-free rate is a component of the Security Market Line (SML). An increase in the risk-free rate shifts the SML upward in a parallel fashion, as it increases the expected return for all assets, not just changing the risk (beta) or the market risk premium.

In the Capital Asset Pricing Model, an Increase in Inflationary