What will happen to the security market line (SML) if the following events occur, other things constant: (1) inflation expectations increase, and (2) investors become more risk averse?
A) shift up and keep the same slope
B) shift up and have less slope
C) shift up and have a steeper slope
D) shift down and keep the same slope
E) shift down and have less slope

Question

Quizplus · Accepted Answer

If inflation expectations increase, the expected return on all securities will increase. This will cause the SML to shift up. Additionally, if investors become more risk averse, the risk premium will increase, causing the SML to have a steeper slope. Therefore, the SML will shift up and have a steeper slope. The correct answer is C.

What Will Happen to the Security Market Line (SML) If