I am having hard time to understand what is meant by the following. Could you please confirm my understanding. 1. Movement along SML line means As business risk increases, it moves along line upwards. Is it correct? 2. The slope represents return per unit of risk for a given investor. Is it right? 3. what is meant by change in slope of SML? Does increase slope means more return/risk? 4. what is meant by parelle shift of SML? 5. Is SML anyway related to change in market conditions such as inflation or monetary policy. Appreciate looking into the issue.
chinni234 Wrote: ------------------------------------------------------- > I am having hard time to understand what is meant > by the following. Could you please confirm my > understanding. > > 1. Movement along SML line means > > As business risk increases, it moves along line > upwards. Is it correct? > I don’t know about “business risk”. I would go with “systematic risk”, i.e., beta is how risky the security is compared to the market. > > 2. The slope represents return per unit of risk > for a given investor. Is it right? > Yep > 3. what is meant by change in slope of SML? > > Does increase slope means more return/risk? > Yep > > 4. what is meant by parelle shift of SML? > That would be the risk free rate changing without changing the slope. > > 5. Is SML anyway related to change in market > conditions such as inflation or monetary policy. > Sure - the slope and intercept of the SML can change based on anything including inflation and monetary policy. The slope represents how people are being rewarded for taking on risk and the rfr is about inflation expectations and money demand. > Appreciate looking into the issue.
JoeyDvivre, Thanks a lot for reply. I understood better now. I just read that shift in SML occurs for change in monetary policy , inflation etc. I am not sure on how slope is affected by change in monetary policy. I read that change in slope affects all risk investments and results from investor willingness to accept risk. Thanks again for the reply Chinni
The slope is the market risk premium E(Rm) - Rfr which can certainly change. (While beta looks like a slope, it’s the variable on the x-axis)
Thanks. I updated my previous post and what i said earlier is not correct.
Glad you got it.
Now do you want to attempt this; Which of the following statements is FALSE? A) The Efficient Frontier plots expected return against unsystematic risk. B) The SML plots expected return against systematic risk. C) The Capital Market Line plots expected return against total risk. D) The equation for the SML (Security Market Line) is: ERstock = kRF + (ERmarket - kRF) Beta.
a?
A is totally messed.