Question

The SML helps determine the risk-aversion level among investors. The flatter the slope of the SMC, the the level of risk aversion. Which of the following statements best describes a shift in the SML caused by increased risk aversion? O The risk-free rate will increase. O The risk-free rate will decrease. O The risk-free rate will remain constant.

Answer 1

Increased risk aversion causes a shift in the SML, and the risk-free rate will decrease.

Step-by-step explanation:

Increased risk aversion leads to a shift in the Security Market Line (SML). The SML represents the relationship between an investment's expected return and its systematic risk (beta). When risk aversion increases, investors become less willing to take on risky investments, which leads to a flatter slope of the SML.

As risk aversion increases, the risk-free rate will typically decrease. The risk-free rate represents the return on a risk-free investment, such as a government bond. When investors are more risk-averse, they prioritize the safety of their investments and are willing to accept a lower return on risk-free assets.