Asked by Ashna Malhotra on Jul 07, 2024
Verified
The Security Market Line (SML) relates risk to return, for a given set of market conditions. If the risk-free rate increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.
Risk-Free Rate
The return on investment with no risk of financial loss.
Security Market Line
A graphical representation that shows the expected return of assets as a function of their systemic risk, represented by beta.
Market Risk Premium
The excess return that investors require for choosing to purchase stocks over risk-free securities.
- Understand the implications of changes in market conditions (e.g., risk-free rate, market risk premium) on the SML.
Verified Answer
TG
Trinity GodinaJul 08, 2024
Final Answer :
D
Explanation :
If the risk-free rate increases, the return required for bearing risk increases as well. As a result, the overall return for equity investments increases, and the SML line shifts up. The slope of the SML line does not change, and the market risk premium and beta are not directly affected by changes in the risk-free rate.
Learning Objectives
- Understand the implications of changes in market conditions (e.g., risk-free rate, market risk premium) on the SML.