Refer to the graph. Consider an asset represented by point F. The process of arbitrage will draw investors to the higher rates of return,
A) increasing both price and the average expected rate of return.
B) changing the intercept of the Security Market Line until it intersects point F.
C) changing the slope of the Security Market Line until it intersects point F.
D) increasing the asset's price and lowering the average expected rate of return.

Question

Refer to the graph. Consider an asset represented by point F. The process of arbitrage will draw investors to the higher rates of return,
A) increasing both price and the average expected rate of return. 
B) changing the intercept of the Security Market Line until it intersects point F. 
C) changing the slope of the Security Market Line until it intersects point F. 
D) increasing the asset's price and lowering the average expected rate of return.

Quizplus · Accepted Answer

According to the graph, point F represents an asset with a relatively low price and a high expected rate of return compared to the Security Market Line (SML). Arbitrage will draw investors to this asset, which will increase its price and lower its expected rate of return until it intersects with the SML. Therefore, the correct choice is D, which suggests that arbitrage will increase the asset's price and lower the average expected rate of return.

Refer to the Graph