Asked by Andrea Weitoschova on Jul 09, 2024
Verified
Assume you are looking at a graph depicting the security market line. If the market risk premium increases, then the:
A) Market rate of return will plot at a lower point on the vertical axis.
B) Intercept point of the security market line will rise up the vertical axis.
C) Point depicting the market rate of return will shift to the right parallel to the horizontal axis.
D) Slope of the security market line will rise while the intercept point remains constant.
E) Slope of the security market line will rise as the intercept point rises up the vertical axis.
Market Risk Premium
The extra return expected by investors for taking on the risk of investing in the stock market over a risk-free rate.
Security Market Line
A line representing the relationship between the expected return of a market security and its risk, as measured by beta.
- Explain the impact of market risk premium changes on the slope and position of the Security Market Line.
Verified Answer
BG
Bruno GuimaraesJul 14, 2024
Final Answer :
D
Explanation :
The security market line (SML) represents the expected return of a security or portfolio in relation to its beta (systematic, or market, risk). The slope of the SML is determined by the market risk premium (the expected return of the market minus the risk-free rate). If the market risk premium increases, the slope of the SML will rise, indicating that investors demand more return for any given level of risk. The intercept point, which is the risk-free rate, remains constant because it is not affected by changes in the market risk premium.
Learning Objectives
- Explain the impact of market risk premium changes on the slope and position of the Security Market Line.