The security market line (SML) relates risk to return, for a given set of market conditions. If expected inflation 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.

Question

Quizplus · Accepted Answer

When expected inflation increases, the required rate of return increases which causes the SML line to shift upward. This is because investors demand a higher return to compensate for the eroding effect of inflation on their investments. The market risk premium and beta may or may not change in response to changes in expected inflation.

The Security Market Line (SML) Relates Risk to Return, for a Given