Which of the following statements is CORRECT?
A) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
B) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
C) If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
D) An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.
E) A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

Question

Quizplus · Accepted Answer

The correct statement is D because the Security Market Line (SML) reflects the relationship between the expected return and the beta of securities. An increase in expected inflation would shift the SML upward uniformly, affecting both riskless assets and average stocks similarly if the real risk-free rate and the market risk premium remain constant.

Which of the Following Statements Is CORRECT